Financial development and economic growth

Abstract The present paper examines the nature and direction of the relationship between financial development and economic growth using both time‐series and panel data from 30 developing countries for the period 1970–1999. The choice of the sample was determined by the availability of data. As such, the exclusion of other developing countries is due to the fact that the data on these countries are missing for some years. The empirical results strongly support the view that financial development and economic growth are mutually causal, that is, causality is bidirectional. There is also some support for the other views presented in the literature (supply‐leading, demand‐leading, and no relationship) but it is not as strong as that for the bidirectional causality. Moreover, the findings of the present paper accords with the view of the World Bank and other empirical studies that the relationship between financial development and economic growth cannot be generalized across countries because economic policies are country specific and their success depends, among others things, on the efficiency of the institutions implementing them.