in the same way, proved to survive. The discovery was made by King and Levine (1993). Overnight, the finance and growth literature was relaunched along an entirely new dimension.

The subsequent literature has been a large one, which I will not attempt to review here. For me its conclusions are summarized in two charts. The first one I call “ _post hoc ergo propter hoc_ ”, because, in itself, its force is no stronger than that. Nevertheless, it is suggestive that the mean GDP growth rate over the next 40 years of country groups sorted by financial depth is so clearly ranked (Fig. 1). King and Levine’s 1993 papers of course went well beyond that. One of their main goals, as mentioned, was to show that this correlation survived the process of controlling for other candidate variables for explaining growth.<sup>1</sup> And it does, whether we look at contemporaneous or initial (1960) data on financial depth.

The other chart (Figure 2) draws on a later paper by Levine, with Loayza and Beck (2000), which is my favorite from this literature, because of the persuasive way it deals with another problem: that of reverse causality (endogeneity). After all, perhaps _post hoc ergo propter hoc_ is not enough (especially if we look at shorter periods than 30 years). Perhaps persistently rapid-growth countries call forth deeper financial systems: if so, then observing a deep financial system in such a country may not be telling us anything about the power of finance to generate growth. The standard way of dealing with this problem in econometrics requires the use of instrumental variables, i.e. variables correlated with financial depth, but not otherwise linked to GDP growth. Employing, in the causal regressions, the predicted value of a country’s financial depth from a regression using such instruments removes the potential reverse causality bias. Finding valid and strong instrumental variables is easier said than done, but LLB employ a recently discovered fact, namely that countries which have inherited variants of English common law tend to have deeper financial systems than those whose legal inheritance is from the Napoleonic code or the distinct German and Scandinavian traditions that are recognized. These legal origins date so far back as to exclude the possibility of feedback from recent growth processes, which helps ensure that they are valid instruments.<sup>2</sup> Figure 2 shows the scatter of financial depth and growth rates in the LLB sample. Two lines are plotted. One is drawn by me as a naïve simple regression, and as such potentially contaminated not only by reverse causality, but by the omission of other causal factors. The other line, marked “model” is the projection of the multivariate relationship estimated by LLB. I learn two striking facts from this figure. First, the relationship is not a very close one: much of the variation in growth is due to other causes. And if a country moved from the lowest decile of financial depth (13%) to the highest (75%) it could expect to improve its growth rate by a lot (over 4 percent in this model) all other things being equal, but there are pairs of countries with a smaller

> 1 Such as initial income level, education, government spending, inflation, trade openness, measures of political liberties and law and order.

> 2 A third requirement for validity, that the instruments have no independent causal effect on GDP growth, is not easily tested.  The well-known over-identification tests do not fully test this, contrary to what many authors seem to believe.

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