Institutions, Innovations, and Growth

Abstract

Financial institutions affect R&D and growth through their roles as corporate control devices with respect to disciplining managers and selecting projects. For an institution which generates a soft-budget constraints problem, we show how it creates conditions for relatively low economic growth when the risk of R&D investment is high. In contrast, in a different financial institution which generates hard-budget constraints, relatively high economic growth can be achieved when the risk of R&D investment is high. However, growth in a soft-budget constraint economy can be high if the risk level of R&D is very low, such as in cases of technological imitation. Our results reconcile the debate on the 'East Asia miracle' vs. the East Asia financial crisis, and they shed light the rise and fall of centralized economies.

JEL Classification: O16