Evidence on growth and financial development using principal components

In the literature on the growth-financial development relationship, many different measures of financial development have been suggested. These are generally highly correlated and are frequently subject to measurement error. In this article, principal components are used as a means of measuring financial development. Using panel data for 30 developing countries on 10 measures of financial development, the properties of the principal components are discussed and their relationships with growth are examined. Estimation by the general method of moments suggests that principal components have a useful role in examining the links between growth and financial development.