A THEORY OF GROWTH, FINANCIAL DEVELOPMENT AND TRADE

This paper presents an analysis of the joint determination of real and financial development. Privately informed designers obtain external f inance for their research projects through incentive-compatible loan c ontracts. Contracts are enforced through costly monitoring activity wh ich lenders may either undertake themselves, or delegate to a financia l intermediary. The analysis establishes a positive, two-way causal re lationship between growth and financial development. In addition, usin g a multi-country version of the model, it is shown how both financial and trade liberalization can accelerate the development of intermedia tion; only trade liberalization has a direct positive effect on growth , however.