The Effects of Financial Sector Development on Innovation as an Engine of Sustained Growth

Abstract

The finance-led growth hypothesis states that financial

development promotes economic growth by enhancing either

efficiency of capital accumulation or technological innovation or

both. A typical strategy to test the validity of the hypothesis is

to regress measures of financial development on aggregate

growth measures such as GDP per capital growth. This type of

approach is problematic because of simultaneity. Furthermore,

the channel of influence from the financial sector to the real

sector is not specified. This paper focuses on the innovation

channel of influence and tests whether financial development

positively affects the rate of technological innovation. By

focusing on a specific channel of influence, simultaneity is

ameliorated. Using a panel of patent application data of

developing countries as a proxy for technological innovation, this

paper provides evidence that financial development seems to be

an important determinant of the rate of technological innovation

across countries and over time.