Working Paper: CEPR ID: DP17877
Authors: Pravin Krishna; Andrei Levchenko; Lin Ma; William Maloney
Abstract: This paper studies the cross-country patterns of risky innovation and growth through the lens of international trade. We use a simple theoretical framework of risky quality upgrading by firms under varying levels of financial development to derive two predictions. First, the mean rate of quality growth and the corresponding cross-sectional variance of quality growth in a country are positively correlated. Second, both the mean and variance of quality changes are positively correlated with the country's level of financial development. We then test these two hypotheses using data on disaggregated (HS10) bilateral exports to the United States. The patterns in the data are consistent with the theory. The mean and the variance of quality growth are strongly positively correlated with each other. Countries with greater financial depth are systematically characterized by higher mean and higher variance in the growth of product quality. Our findings suggest a mean-variance trade-off in product quality improvements along the development path. Increases in financial depth do not imply lower variability of changes in the product space.
Keywords: Product Quality; Financial Development; Risk
JEL Codes: F14; O3; O4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| mean growth rate in product quality (L15) | variance in quality growth (L15) |
| financial development (O16) | product quality growth (L15) |
| financial development (O16) | variance in product quality growth (L15) |
| financial development (O16) | product quality growth and dispersion (L15) |
| Asian Financial Crisis (F65) | financial development (O16) |