Financial Structure and Economic Development: Firm, Industry, and Country Evidence

Abstract

The authors explore the relationship between financial structure - the degree to which a financial system is market- or bank-based - and economic development. They use three methodologies: 1) The cross-country approach uses cross-country data to assess whether economies grow faster with market- or bank-based systems. 2) The industry approach uses a country-industry panel to assess whether industries that depend heavily on external financing grow faster in market- or ban-based financial systems, and whether financial structure influences the rate at which new firms are created. 3) The firm-level approach uses firm-level data across a broad selection of countries to test whether firms are more likely to grow beyond the rate predicted by internal resources, and short-term borrowings in market- or bank-based financial systems. The cross-country regressions, the industry panel estimations, and the firm-level analyses, provide remarkably consistent conclusions: a) Financial structure is not an analytically useful way to distinguish financial systems. b) Financial structure does not help us understand economic growth, industrial performance, or firm expansion. c) The results are inconsistent with both market-based and bank-based views. In other words, economies do not grow faster, industries dependent on external financing do not expand faster, new firms are not created more easily, firms' access to external finance is not greater, and, firms do not grow faster in either market- or bank-based financial systems. The authors find overwhelming evidence that the overall level of financial development, and the legal environment in which financial intermediaries, and markets operate, critically influence economic development.