Finance and economic development: how do they work together?

The economy is linked to finance by its need for capital. Indeed, it is finance that provides capital so that the economy can function and develop. The role of finance is to allocate a country’s financial resources to the most productive entities or sectors so that they can develop. These financial resources are limited and the lack of capital to be allocated to a strategic sector is a major obstacle to a country’s economic growth.

What is finance?

Finance comprises the institutions and mechanisms that provide the economy with capital so that it can not only function but also develop. It is an activity guided by the law of prices and returns. It is also essential to a country’s economic development. All financing is risky because the providers of capital are always uncertain about the returns on their investments. These capital providers are hampered by problems such as the lack of information about the entities (companies, households, …) to which they entrust their money, the period during which their capital is tied up (when they can invest it elsewhere at more advantageous rates) and finally the risk of losing their investment. Finance therefore brings capital to the economy.

Finance and economic development

Without capital inflows from the financial sector, the economy cannot function. The main role of finance in relation to the economy is to allocate resources, in the form of capital, to those sectors that are most productive and are likely to bring the maximum return. To identify the most productive economic sectors, financial actors learn about the situation of all sectors of a country’s economy, calculate the risks of losses and ensure the availability of their capital at the right times. With this information gathering and calculation, finance plays a very important role in a country’s economic growth.

Economic growth and finance

The role of finance is essential for economic growth because if a key sector lacks capital, a country’s economic growth will be affected or slowed down. Finance ensures that a country’s available but limited capital is invested in a profitable and responsible manner. Before making a decision that involves financial flows, financial actors need to be well informed about the situation of the sector in which they wish to invest.