Financial dependence and growth: The role of input-output linkages

Abstract

We widen the understanding of the finance-growth nexus by accounting for the indirect effect of financial development through input-output (IO) linkages in determining the growth of industries across countries. If financial development is expected to promote disproportionately more the growth of industrial sectors that are more in need of external finance, it also favours more the industries that are linked by IO relations to more financially dependent industries. We explore this new channel in a sample of countries at different development stages over the period 1995–2007. Our results highlight that financial development, besides easing the growth of industries highly dependent on external finance, also fosters the growth of industries strongly linked to highly financially dependent upstream industries. Moreover, the indirect effect - propagated through IO linkages - of finance has a higher and non-negligible role compared to the direct effect and its omission leads to a biased and underestimated perception of the role of finance for industries’ growth.