Adjustment to Target Capital, Finance and Growth
Universitat Pompeu Fabra - Faculty of Economic and Business Sciences; Centre for Economic Policy Research (CEPR); Institute for the Study of Labor (IZA)
London Business School; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
CEPR Discussion Paper No. 5969
Does financial development result in capital being reallocated more rapidly to industries where it is most productive? We argue that if this was the case, financially developed countries should see faster growth in industries with investment opportunities due to global demand and productivity shifts. Testing this cross-industry cross-country growth implication requires proxies for (latent) global industry investment opportunities. We show that tests relying only on data from specific (benchmark) countries may yield spurious evidence for or against the hypothesis. We therefore develop an alternative approach that combines benchmark-country proxies with a proxy that does not reflect opportunities specific to a country or level of financial development. Our empirical results yield clear support for the capital reallocation hypothesis.
Number of Pages in PDF File: 39
Keywords: Financial development, sector analysis, growth, measurement error, investment opportunities
JEL Classification: E230, E440, F300, G100, O400working papers series
Date posted: January 5, 2007
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