Discussion Paper Details

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Title: Financial Innovation and Endogenous Growth

Author(s): Luc Laeven, Ross Levine and Stelios Michalopoulos

Publication Date: September 2009

Keyword(s): Corporate Finance, Economic Growth, Entrepreneurship, Financial Institutions, Invention and Technological change

Programme Area(s): Financial Economics

Abstract: We model technological and financial innovation as reflecting the decisions of profit maximizing agents and explore the implications for economic growth. We start with a Schumpeterian endogenous growth model where entrepreneurs earn monopoly profits by inventing better goods and financiers arise to screen entrepreneurs. A novel feature of the model is that financiers also engage in the costly, risky, and potentially profitable process of innovation: Financiers can invent more effective processes for screening entrepreneurs. Every existing screening process, however, becomes less effective as technology advances. Consequently, technological innovation and, thus, economic growth stop unless financiers continually innovate. Historical observations and empirical evidence are more consistent with this dynamic model of financial innovation and endogenous growth than with existing models of financial development and growth.

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Bibliographic Reference

Laeven, L, Levine, R and Michalopoulos, S. 2009. 'Financial Innovation and Endogenous Growth'. London, Centre for Economic Policy Research.