Historical evidence on the finance-trade-growth nexus

We study linkages between financial development, international trade, and long-run growth using data since 1880 for 17 now-developed “Atlantic” economies and a set of cross country and dynamic panel data models. We find that finance and trade reinforce each other in data before 1930, but that these effects do not persist after the Second World War. Financial development affects growth positively throughout the sample period, while trade affects growth strongly and independently after 1945. We attribute the rising importance of trade to major post-World War II changes in tariffs and quantity restrictions associated with the GATT, the establishment of the European Common Market, and the gradual elimination of capital controls after 1973. The findings are robust to the use of ‘deep’ fundamentals such as legal origin and indicators of the political environment as instruments for financial development and trade. Financial development, however, links more closely than trade to these fundamentals.