Economic growth and financial development: a legal explanation

Abstract

This thesis presents a multi-national empirical study of the relationship between financial development and economic growth from the legal protection perspective based on both micro firm-level data and macro country-level data. Our study comprehensively examines the investor legal protection in terms of legal statues, legal enforcement and legal origins. We first examine the mechanism through which the legal system affects firm investment behaviour. The study suggests that a well-functioning legal system will benefit financial development; consequently access to external finance in the financial sector will be easier, thus firms are less sensitive to internal financing. Secondly, we investigate this relationship by taking into account of the cost of capital. The empirical study provides evidence that stronger legal protection will lead to a decrease in the cost of debt and equity, since it promotes financial development and thus funds are more available. Finally, we construct four new indices to measure financial development from the qualitative aspect rather than the quantitative aspect. The indices measure the liquidity and volatility of financial market while assessing the efficiency of banking and non-banking sector. We find that economic growth is accelerated by financial development which is exogenously determined by the functioning of legal systems.