financial depth difference (30 percentage points) but a growth difference more than twice as great. Second, the modeled impact of finance on growth is much stronger than the naïve regression would have indicated. That is to say, the combined effect of reverse causality and omitted variables bias is to mask rather than to exaggerate the effect.<sup>3</sup>

# 3. **Not mainly for the rich**

Aggregate economic growth is, of course, the key to economic prosperity of rich and poor alike, and the finding that financial development contributes to it must be inform policy that seeks to achieve a reduction in global poverty.

Yet for some observers emphasizing finance seems to be getting the wrong end of the stick. Noting such characteristics as the high salaries paid on average in the financial sector, these observers suppose that if the financial sector prospers, this may mean a deterioration in the distribution of income: more for well-paid investment bankers, not much for their drivers or cleaners. Rajan and Zingales (2003) cite Tom Wolfe’s novel _The Bonfire of the Vanities_ as illustrative of the widely held view that finance benefits only, or mainly, the rich. If this casual prejudice was borne out in reality then one would become somewhat ambivalent about relying on financial development as a priority instrument for tackling poverty in developing economies.

But, as Rajan and Zingales note, a healthy financial system can be a powerful antimonopoly tool, providing the lubrication for the emergence of competitors that can undermine the power of incumbent firms, and the means for poor households and smallscale producers to escape the tyranny of exploitative middlemen. In contrast, the undeveloped financial system, in their words, can be “clubby, uncompetitive and conservative”. If so, financial development _could_ be pro-poor. But is it?

To be sure, financial development promotes growth, and we have extensive evidence that growth worldwide has been a powerful mechanism for reducing poverty. Furthermore, the lowest quintile shares in the national rate of growth. To use the terminology of fiscal policy, growth is neither progressive nor regressive: it is – on average – neutral (DollarKraay 2002). That means that the rich get more dollars from every increment of growth than do the poor, and that no improvement can be expected in relative poverty from the growth process _per se_ , but it also means that absolute poverty declines.

But the Dollar-Kraay results do not amount to saying that “a rising tide raises all boats.” The tidal analogy is quite imperfect. Of the many drivers of growth it could still be that financial development is regressive. This indeed is the prediction of the widely cited model of Greenwood and Jovanovic (1990). They argue that getting involved in the

> 3 The finance-growth relationship continues to be studied, and even challenged, as in, for example, Favar (2003), who fails to find significant coefficients on finance in instrumented growth regressions.  At bottom the main problem is typically one of weak instruments: OLS estimates still indicating causality.  Such negative findings are not sufficient to revise the main-line view that finance causes economic development based, as it is, not only on the studies cited but on a wide range of cross-country studies, including those based on firm-level, industry-level and state-level evidence (see World Bank, 2001, and the papers cited therein).

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