Financial Development and Productivity Growth in Stagnant Industries

Abstract

Over recent decades, the U.S. economy has experienced a rapid expansion in stagnant industries, or those with low productivity growth. In this paper, we investigate whether financial development improves productivity growth in these industries. Testing reveals that, despite no significant changes in aggregate productivity growth, stagnant industries experience remarkable post-deregulation productivity growth improvement. We confirm that this result is not an artefact of the growing consumer demand for service industries, nor is it driven by the skilled labor migration from progressive to stagnant industries. Subsequent analysis also shows that stagnant industries’ employment share declines in the wake of the reforms, ameliorating Baumol’s Cost Disease. Results are strongest in small states, and are likely the outcome of improved capital allocation rather than reduced cost of debt funding. Taken together, our findings highlight the vital role of financial development in reducing productivity gap among sectors and, as such, have significant policy implications for regulators.

Keywords: Financial Access; Bank Deregulation, Productivity, Stagnant Industry

JEL Classification: E24, E59, G21, O47