The Coevolution of the Real and Financial Sectors in the Growth Process

The role of debt and equity changes over time and with the levelof development. What are these changes, and why should theysystematically occur across different countries and time periods?This article characterizes financial innovation as a dynamicprocess that both influences and is influenced by the developmentof the real sector. It focuses on the emergence and developmentof equity markets, using a model that allows for growth andfor capital accumulation that is financed externally througha combination of debt and equity. As an economy develops, theaggregate ratio of debt to equity will generally fall; yet,debt and equity remain complementary sources for the financingof capital investments. The results suggest how various governmentpolicy actions might affect capital accumulation and equitymarket activity.