The interest group theory of financial development: evidence from regulation

We use a new dataset of de jure measures of trade, capital account, product market and domestic financial regulation for 91 countries from 1973 to 2005 to test Rajan and Zingales’s (2003) interest group theory of financial development. In line with the theory, we find strong evidence that trade liberalisation is a leading indicator of domestic financial liberalisation. This result is robust to the use of different data frequencies, estimation methods and a check for non-linear effects. However, in contrast to the theory, we do not find consistent evidence of an effect of capital account liberalisation on financial development.