Financial Shocks and TFP Growth

Abstract

We investigate how changes in industries’ funding costs affect total factor productivity (TFP) growth. Panel regressions with 31 U.S. and Canadian industries between 1991 and 2007, using industries’ dependence on external funding as an identification mechanism, show that higher funding costs reduce TFP growth. This finding is robust to controlling for industry size and changes in factor utilization. Based on a theoretical model, the estimates suggest that financial shocks distort the allocation of factors across firms within an industry, reducing its TFP. Lower productivity growth accounts for a large fraction of the negative impact of funding costs on output.

Keywords: Business cycles, total factor productivity, financial shocks

JEL Classification: E23, E32, E44