Alireza Rostami et al./ Elixir Fin. Mgmt. 48 (2012) 9164-9170 9164 Introduction Economic development is subject to availability of the physical and human capital. Financial resources are needed to ascertain the availability of these capitals. In fact, an economic system equipped with an effective and efficient financial system can mold this investment function in an optimal manner. For example, financial system can contribute towards this end by encouraging the public to save and reallocate their savings to productive investment projects, while competently addressing the issues of risk and return. Hence, financial system development is the process involving actions such as founding and expounding functions of financial institutions, developing new (innovative) financial products and developing markets for these products. However, the recent financial crisis in the developed economies is an example of the downside of the financial development and is an indication of the complexities involved in relationship between economic and financial development. Moreover, despite the fact that the two are related, the direction of causality in this relationship is yet another undecided phenomenon. Economists and states have long been interested in the relationship between .financial development and economic growth, and promoting .financial development has been an integral part of many countries.growth strategies. A body of literature since the work of King and Levine (1993) and Rajan and Zingales (1998) has found a positive link between .Financial development and growth, yet Levine (2004), reviewing the empirical literature, cautions that available evidence suers from .serious short comings, .and that .we are far from de.nitive answers to the questions: Does finance cause growth, and if so, how?.A critical impediment to a better understanding of this relationship is the lack of exogenous variation in variables of interest: the literature has relied primarily on evidence from cross-country comparisons. Economists disagree sharply about the role of the financial sector in economic growth. Finance is not even discussed in a collection of essays by the “pioneers of development economics” (Meier and Seers, 1984), including three Nobel Prize winners, and Nobel Laureate Robert Lucas (1988, p.6) dismisses finance as an “over-stressed” determinant of economic growth. Joan Robinson (1952, p. 86) famously argued that "where enterprise leads finance follows." From this perspective, finance does not cause growth; finance responds to changing demands from the “real sector.” At the other extreme, Nobel Laureate Merton Miller (1988, p.14) argues that, “[the idea] that financial markets contribute to economic growth is a proposition too obvious for serious discussion.” Drawing a more restrained conclusion, Bagehot (1873), Schumpeter (1912), Gurley and Shaw (1955), Goldsmith (1969), and McKinnon (1973) reject the idea that the finance- growth nexus can be safely ignored without substantially limiting our understanding of economic growth. Research that clarifies our understanding of the role of finance in economic growth will have policy implications and shape future policy-oriented research. Information about the impact of finance on economic growth will influence the priority that policy makers and advisors attach to reforming financial sector policies. Furthermore, convincing evidence that the financial system influences long-run economic growth will advertise the urgent need for research on the political, legal, regulatory, and policy determinants of financial development. In contrast, if a sufficiently abundant quantity of research indicates that the operation of the financial sector merely responds to economic development, then this will almost certainly mitigate the intensity of research on the determinants and evolution of financial systems. Tele: E-mail addresses: mostafa.emami@modares.ac.ir © 2012 Elixir All rights reserved The investigation of the relation between financial development and economic development: reviews, appraises, and critiques theoretical and empirical research Alireza Rostami 1 , Kamran Nazari 1 and Mostafa Emami 2 1 Department of Business Management, Payam Noor University, Kermanshah, Iran. 2 Assistant Professor, Faculty of Economic and Managements Tarbiat Modares University, Tehran, Iran ABSTRACT This paper reviews, appraises, and critiques theoretical and empirical research on the connections between the operation of the financial system and economic growth. It describes the role of financial system development in economic growth at the macro level, both theoretically and empirically. It also describes briefly the relationship of corporate finance and firm performance. It finally concludes the review and presents some policy implications in view of the reviewed literature. Furthermore, theory and evidence imply that better developed financial systems ease external financing constraints facing firms, which illuminates one mechanism through which financial development influences economic growth. The paper highlights many areas needing additional research. © 2012 Elixir All rights reserved. ARTICLE INFO Article history: Received: 1 May 2012; Received in revised form: 15 June 2012; Accepted: 28 June 2012; Keywords Economic Development, Financial development, Technological Change. Elixir Fin. Mgmt. 48 (2012) 9164-9170 Finance Management Available online at www.elixirpublishers.com (Elixir International Journal)