However, attempts to judge the relative success of economies with large banking systems and those with large or active stock exchanges have so far proved, in my reading, inconclusive (cf. Demirgüç-Kunt and Levine 2002). It seems that countries have done rather well with a wide variety of relative bank- and market-intensities. Perhaps each of these advanced countries has seen an adaptation of its financial structure to accommodate both the particular needs of its nonfinancial sectors and its inherited legal, administrative and informational infrastructure.

# 5. **Using data on infrastructure to construct a composite indicator of financial development**

Indeed, intriguingly, what is found consistently across many studies is that the functioning of financial markets is more effective where certain governmental, informational and legal pre-conditions are also present. In this section we consider how such findings could be drawn upon to help construct a more balanced and comprehensive measure of financial development that captures these additional dimensions.

Perhaps a _caveat_ is not out of order here. We have also seen how similar variables have been employed as econometric _instruments_ for banking depth in the finance and growth literature. But a variable cannot logically be both a valid instrument and an appropriate component in a composite financial development indicator. After all, a valid instrument must have its effect on the dependent variable (growth in the case above) only through the variable being instrumented. Its exclusion from the main causal regression must be justified. In devising a composite indicator, care should be taken to avoid being trapped in a contradiction where we assert that a particular environmental or infrastructural variable has a direct effect, and in addition rely on the results of some study where it has been employed as an instrument.<sup>20</sup> Bearing this caution in mind, but forging bravely ahead, let me assert as a stylized summary of the literature that legal, regulatory and informational infrastructure has a strong impact on the degree to which particular financial structures (banking systems of a certain depth, stock markets of a certain level of activity) are actually effective in delivering the benefits that we would like to see: long-term growth, insulation, access to SMEs and microenterprises, and poverty reduction. Some of this infrastructure may also have an independent direct effect.

If infrastructure is a crucially important component of financial development, it seems that a summary measure of financial development should include it in some way. In the remainder of the paper I would like to sketch an approach to devising a composite indicator, and offer a preliminary examination of whether it would make much difference in practice as compared with conventional size-based measures of financial development.

> outsiders in ownership is also low, and that the stock market may not therefore be performing much of a governance function.

> 20 There has to be some question as to whether some of the institutional variables that have been employed as instruments really do satisfy the necessary exclusion criteria: as mentioned above this is not something that is easily tested.

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