Financial development benefits poor

Most economic literature finds that financial development produces faster economic growth, but it has been unclear whether it also shrinks poverty. A new paper from the National Bureau of Economic Research finds that financial development helps the poor as well as the rich.

The authors used data on the economies of 52 nations over the period 1960-1999 to test the relationship between financial development and the distribution of income. Additionally, they used data on 58 developing countries for the period 1980-2000 to assess the relationship between financial development and poverty alleviation.

The authors find that in countries with increased financial development, income inequality falls more rapidly and poverty rates decrease at a faster rate than would otherwise be the case. For example:

  • In Chile – with a high private credit ratio of 54 per cent – the percentage of the population living on less than $1 a day shrank at an annual rate of 14 per cent between 1987 and 2000.

  • In contrast, Peru – with a low private credit ratio of 13 per cent – saw the number of people living on $1 a day increase at an annual rate of 19 per cent.

  • The average income of Brazil would have grown at more than 1.5 per cent per year instead of not at all from 1960-1999 if Brazil had the same level of financial intermediary development as South Korea.

    Thus, the authors note, the impact of financial development on poverty is quite large. It lowers income inequality and boosts growth without the potential disincentives to entrepreneurs and others resulting from policies that directly redistribute income and other resources.

    Source: David R. Francis, Financial Development Helps the Poor in Poor Countries, National Bureau of Economic Research, NBER Digest, July 2005. Based on Thorsten Beck, Asli Demirguc-Kunt, and Ross Levine, Finance, Inequality, and Poverty: Cross Country Evidence, National Bureau of Economic Research, Working Paper, No. 10979, December 2004.

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    FMF Policy Bulletin/ 04 October 2005
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