Working Paper: CEPR ID: DP1276
Authors: Angel de la Fuente; Jose Maria Marin
Abstract: This paper analyses the interaction between capital accumulation, technological progress and financial development. Growth is sustained by the development of new varieties of intermediate goods. Innovation is risky and the probability of success depends on entrepreneurs' actions, which can only be imperfectly observed by outsiders through the use of a costly monitoring technology. Financial intermediaries emerge to avoid the duplication of monitoring activities and negotiate incentive contracts with innovators. Monitoring intensity is determined endogenously as a function of factor prices and determines the risk premium required by risk-averse researchers. Natural forward and backward links arise between finance and innovation. By allowing for better risk sharing, closer monitoring yields a higher level of innovative activity in equilibrium and faster growth. Under plausible assumptions, the resulting changes in factor prices lower the relative cost of monitoring, leading to a further increase in the efficiency of the financial sector.
Keywords: growth; financial development
JEL Codes: G20; O16; O30; O40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial intermediaries improve risk-pooling services (G23) | Resource flow to innovative activities (O36) |
| Real sector growth (O49) | Changes in factor prices (F16) |
| Changes in factor prices (F16) | Return on information-gathering for intermediaries (D83) |
| Real sector growth (O49) | Financial development (O16) |
| Financial development (O16) | Resource flow to innovative activities (O36) |
| Real sector growth (O49) | Monitoring intensity (C41) |
| Monitoring intensity (C41) | Risk premium required by entrepreneurs (L26) |
| Resource flow to innovative activities (O36) | Successful projects (O22) |