Does Financial Development Promote Innovation in Developing Economies? An Empirical Analysis

22 Pages Posted: 7 Jul 2017

See all articles by Maria Aristizabal‐Ramirez

Maria Aristizabal‐Ramirez

University of Michigan at Ann Arbor

Maria Camila Botero‐Franco

Bancolombia

Gustavo J. Canavire-Bacarreza

Inter-American Development Bank (IDB); IZA Institute of Labor Economics

Date Written: August 2017

Abstract

Using firm‐level data from 2006 to 2013 for a set of developing countries, we examine the effects of financial development on innovation. Financial development boosts innovation by improving resource allocation and investment in strategic sectors as well as facilitating technology to promote growth. Using binary response models and instrumental variable techniques to correct for endogeneity, we find robust but puzzling results. Contrary to most of the existing literature, financial development has a negative effect on the probability of a firm to innovate in developing countries. This effect is conditional on firm size, and only larger firms benefit from financial development. These results are robust to different measures of financial development and econometric specifications. We argue that this is a result of the design of the financial system in regard to the lack of capital and institutional system. Consequently, developing countries should first generate appropriate institutional conditions if they want financial development to spur growth through innovation.

Keywords: financial development, innovation, economic growth, developing countries

Suggested Citation

Aristizabal‐Ramirez, Maria and Botero‐Franco, Maria Camila and Canavire Bacarreza, Gustavo Javier, Does Financial Development Promote Innovation in Developing Economies? An Empirical Analysis (August 2017). Review of Development Economics, Vol. 21, Issue 3, pp. 475-496, 2017. Available at SSRN: https://ssrn.com/abstract=2998422 or http://dx.doi.org/10.1111/rode.12314

Maria Aristizabal‐Ramirez (Contact Author)

University of Michigan at Ann Arbor ( email )

500 S. State Street
Ann Arbor, MI 48109
United States

Maria Camila Botero‐Franco

Bancolombia

Colombia

Gustavo Javier Canavire Bacarreza

Inter-American Development Bank (IDB) ( email )

1300 New York Avenue NW
Washington, DC 20577
United States

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

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