estment efficiency and mobilization of savings are improved, promoting economic growth through effective integration of financial markets and elimination of segmentation, (Debraj, 1998).
Additionally, from other aspects; a country’s economic growth depends on its population size, human capital, technological advancements and national resources. Economists generally evaluate economic growth focusing on factors that improve GDP per capita.
GDP= C+I+G+EX-IM.
This general equation de
notes the major components of gross domestic production, notably C (consumption), I (Investment), G (Government expenditure) and net export (EX-IM). The process of production requires some inputs such as labor and capital. The growth potential of a nation to a great extent depends on the effectiveness of the labor force and the country’s technological advancement level. If production level is higher, the living standards will be higher too. The income can be consumed or saved. The intermediation mechanism alone (savings conversion into productive investments) does not necessarily guarantee long term economic growth because of diminishing marginal return to capital.
Output is increased by either increasing labor or capital. However, increasing the capital, while labor is constant, will raise the marginal productivity up to some maximum point from which it will start declining, (this is known as diminishing marginal productivity).
In economic growth theory, the Solow Growth Model considers the following variables in account; technological progress, population growth and capital accumulation. But, capital, itself, may not maintain growth, due to diminishing marginal productivity. Additionally, population growth, itself, might not influence growth. However, among these factors, technological progress is essential to economic growth, (Burda and Wyplosz, 2005)
FINANCIAL INTERMEDIATION AND GROWTH
There is a growing interest in the correlation between economic growth and financial intermediation (Pagano, 1993). This correlation was specifically studied by Shaw (1973) and Goldsmith (1969) and they generated considerable evidence that financial development is related with growth. Economists mostly focused on the link between endogenous economic growth and financial development. Many argued that financial growth is an endogenous factor to economic growth and that there could be self-sustaining growth with no exogenous technical progress, and also that the growth rate could be related to income distribution, preferences, institutional arrangements and technology, (Pagano, 1993).
Neoclassical models usually take the rate of technological progress (g) as exogenous, and therefore cannot explain persistent differences in the rate of growth across countries. The Solow Growth Model identified changes in the growth of labor force, capital investment and technology as key drivers of economic growth, (Khatri, Aryal and Saptoka 2008). In this model, diminishing returns to the accumulation of capital plays a vital role in limiting growth in the neoclassical model, (Aghion and Howitt 1998:24). When there is no change in technology, suppose labor force remains the same, growth will finally stop at some point, if capital rise cannot compensate for the capital depreciation.
Nevertheless, in the endogenous growth models, the other determinants of economic
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