Historical Evidence on the Finance-Trade-Growth Nexus
Michael D. Bordo, Peter L. Rousseau
NBER Working Paper No. 17024
Issued in May 2011
We study linkages between financial development, international trade, and long-run growth using data since 1880 for seventeen now-developed “Atlantic” economies and a set of cross-country and dynamic panel data models. We find that finance and trade reinforced each other before 1930, but that these effects did not persist after the Second World War. Financial development has positive effects on growth throughout the sample period, while trade affects growth strongly and independently after 1945. We attribute the rising importance of trade in explaining growth to major post-World War II changes in tariffs and quantity restrictions associated with the GATT, the establishment of the European Common Market, and the gradual elimination of capital controls after 1973. The findings are robust to the use of ‘deep’ fundamentals such as legal origin and indicators of the political environment as instruments for financial development and trade. Financial development, however, is more closely linked to these fundamentals than trade.
When all the debate over whether financial innovation added any value to society was going on, and folks like Volcker were saying that there was no evidence that it did, I always wondered what the evidence was. I've always thought that countries with deep, liquid financial markets had better economic performance than those that did not. I've always thought that financial innovation helped to create deep, liquid financial markets. Not sure this paper will settle that question, but it's worth a look.