Does financial development help to align growth opportunities with growth? Evidence from industry-level data

Abstract

Financial institutions are expected to play a crucial role in reallocating resources in favor of industries facing greater global and local shocks to growth opportunities. Fisman and Love, in their paper entitled “Financial development and intersectoral allocation: A new approach”, argue that growth opportunities are unobservable and propose a new methodology to test the capital allocation hypothesis. The methodology is based on correlations in the patterns of intra-industry growth between two countries and similarities in the level of financial development and income. This paper extends their methodology by proposing direct and forward-looking measures of local and global growth opportunities, obtained by interacting the country’s patterns of industrial specialization with industry-level price-earnings ratios, as in the paper “Global growth opportunities and market integration” by Bekaert et al. The results, obtained in a cross-section framework including 37 developed and developing countries over the period 1992–2006, confirm the relevance of financial development to promote economic growth and to help industries in taking advantage of global and local growth opportunities. They also show that the methodology developed by Fisman and Love can be extended to include direct measures of growth opportunities.