Patterns of Industrial Development Revisited: The Role of Finance

Abstract

We re-examine the role of financial market development in the intersectoral allocation of resources. First, we characterize the assumptions underlying previous work in this area, in particular, that of Rajan and Zingales (1998). We show that they are implicitly testing whether financial intermediaries allow firms to better respond to global shocks to grow th opportunities . We then propose an alternative test that more efficiently tests this hypothesis, using statistical techniques developed in the social networks literature. Specifically, we find that countries have more highly correlated growth rates across sectors when both countries have well-developed financial markets, suggesting that financial markets play an important role in allowing firms to take advantage of global growth opportunities. These results are particularly strong when financial development takes into account both the level and composition of financial development: private banking appears to play a particularly important role in resource allocation. Our technique allows us to further distinguish between this ‘growth opportunities’ hypothesis and the related ‘finance and external dependence’ hypothesis, which would imply that countries with similar levels of financial development should specialize in similar sectors. We do not find evidence in support of this alternative view of finance and development.