Working Paper: CEPR ID: DP5969
Authors: Antonio Ciccone; Elias Papaioannou
Abstract: Does financial development result in capital being reallocated more rapidly to industries where it is most productive? We argue that if this was the case, financially developed countries should see faster growth in industries with investment opportunities due to global demand and productivity shifts. Testing this cross-industry cross-country growth implication requires proxies for (latent) global industry investment opportunities. We show that tests relying only on data from specific (benchmark) countries may yield spurious evidence for or against the hypothesis. We therefore develop an alternative approach that combines benchmark-country proxies with a proxy that does not reflect opportunities specific to a country or level of financial development. Our empirical results yield clear support for the capital reallocation hypothesis.
Keywords: financial development; growth; investment opportunities; measurement error; sector analysis
JEL Codes: E230; E440; F300; G100; O400
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial Development (O16) | Faster Capital Reallocation (D25) |
| Faster Capital Reallocation (D25) | Faster Value-Added Growth in Industries with Global Investment Opportunities (F64) |
| US Industry Capital Growth (L60) | Estimated World-Average Industry Opportunities (L69) |
| Financial Development (O16) | Growth in Industries with Global Investment Opportunities (F64) |