Abstract
We introduce imperfect creditor protection in a multi-country version of Schumpeterian growth theory with technology transfer. The theory predicts that the growth rate of any country with more than some critical level of financial development will converge to the growth rate of the world technology frontier, and that all other countries will have a strictly lower long-run growth rate. The theory also predicts that in a country that converges to the frontier growth rate, financial development has a positive but eventually vanishing effect on steady-state per-capita GDP relative to the frontier. We present cross-country evidence supporting these two implications. In particular, we find a significant and sizeable effect of an interaction term between initial per-capita GDP (relative to the United States) and a financial intermediation measure in an otherwise standard growth regression, implying that the likelihood of converging to the U.S. growth rate increases with financial development. We also find that, as predicted by the theory, the direct effect of financial intermediation in this regression is not significantly different from zero. These findings are robust to alternative conditioning sets, estimation procedures and measures of financial development.
Highlights
Most current theories of the cross-country distribution of per-capita income imply that all countries share the same longrun growth rate
The likelihood that a country will converge to the frontier growth rate increases with its level of financial development, and 2. in a country that converges to the frontier growth rate, financial development has a positive but eventually vanishing effect, ceteris paribus, on the steady-state level of per-capita GDP relative to the frontier
If our results were fragile, if the main determinant of convergence were not financial development but something else that was just correlated with financial development, or if our legal instruments were working on growth and convergence primarily through some channel other than financial development, the addition of at least some of these variables and their interaction with initial relative output should destroy the explanatory power of F 1⁄7 ( y Ϫ y1) in our growth regression, or make the coefficient f on F significantly different from zero
Summary
Most current theories of the cross-country distribution of per-capita income imply that all countries share the same longrun growth rate (of TFP or per-capita GDP). This paper explores the hypothesis that financial constraints prevent poor countries from taking full advantage of technology transfer and that this is what causes some of them to diverge from the growth rate of the world frontier It introduces credit constraints into a multicountry version of Schumpeterian growth theory with technology transfer, and shows that the model implies a form of club convergence consistent with the broad facts outlined above. We use the same data, conditioning sets, instruments, and robustness checks as Levine, Loayza, and Beck [2000], who found a strong and robust effect of the level of financial development in a standard cross-country growth regression We add to their regression an interaction term between the log of initial per-capita GDP (relative to the United States) and financial development, and interpret a negative coefficient as evidence that low financial development makes convergence less likely. We present evidence to the effect that the main channel through which financial development affects convergence is productivity growth, as implied by the theory, rather than capital accumulation, and show that our results are robust to elimination of outliers, to alternative conditioning sets, to alternative estimation procedures and to alternative measures of financial development
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