Indicators of Financial Development GEORGE M. VON FURSTENBERG and MICHELE FRATIANNI ABSTRACT Finance long has been described as the “governor” of economic development. Yet there are no agreed indicators of financial development or measures of the efficiency with which finance provides services to other sectors. This paper clarifies the choices by dis- tinguishing price from quantity indicators of financial development. It recommends increased use of measures of spread between the required rate of return on productive investment and the rate of return on intermediated savings as soon as such data can be obtained from liberalized financial markets. For concreteness, data references are made to Mexico and Chile. INTRODUCTION Financial development is a multidimensional process made possible by the privatization of the “real” economy in developing countries. Gertler and Rose (1994, p. 32) have character- ized it as generally involving: an evolution from self finance to external finance, the devel- opment of intermediation, and the subsequent development of markets for direct credit, increased access to world capital markets, and, finally, narrowing of the spread between loan and deposit rates, along with a rise in the riskless rate. A low level of such development may prevail by design or by default. Governments are inclined to repress the financial sector in countries with costly, and correspondingly poor, tax administration and enforcement because that sector can then be made to yield “easy” resources for the public budget through high money growth and inflation. Yet suppressing the domestic financial sector conflicts with the nation’s development goals, for the private financial sector plays a pivotal role in economic growth: mobilization and efficient alloca- tion of savings, the development of liquid asset markets, and informed venture and insur- ance pricing are among its chief contributions to that process. But indicators are needed to gauge the efficiency of the services provided by the financial sector if it is viewed as pro- viding crucial inputs, including organization and information inputs, to other sectors. The degree of financial development of countries has been determined by either compar- ing prices or quantities, specifically, interest rate spreads or stock-flow ratios in which money or debt aggregates are compared with GDP. We prefer price-based to quantity- based indicators of financial development because they relate most directly to measures of economic efficiency and welfare. This paper describes both types of indicators and exam- ines how they may relate to the efficiency of financial services and the stage of economic development. Before developing the price-based concept and measure, we review the more familiar, quantity-based indicators already tested in the literature. The concluding part assesses the ability of each type of indicator to reveal the level of financial development in George M. von Furstenberg, Department of Economics, and Michele Fratianni l School of Business, Indiana University, Bloomington, IN 47405. North American Journal of Economics & Finance 7(l): 19-29 Copyright 0 1996 by JAI Press Inc. ISSN 1062-9408 All rights of reproduction in any form reserved