The Politics of Financial Development : The Role of Interest Groups and Government Capabilities

Financial development is good for long term growth. So why doesn't every country pursue policies that render full financial development? In this paper, building on a profuse political economy literature, we build a theoretical model that shows that the intensity of opposition by incumbents depends on both their degree of credit dependency and the role of governments in credit markets. We provide empirical evidence for this claim. The results suggest that lower opposition to financial development leads to an effective increase in credit markets' development only in those countries that have high government capabilities. Moreover, improvements in government capabilities have a significant impact on credit market development only in those countries where credit dependency is high (thus, opposition is low). We thus contribute to this rich literature by providing a unified account of credit market development that includes two of its main determinants, traditionally considered in isolation