Does Financial Liberalization Improve the Allocation of Investment? Micro Evidence from Developing Countries

Using firm level panel data from twelve developing countries we explore if financial liberalization improves the efficiency with which investment funds are allocated. A summary index of the efficiency of investment allocation that measures whether investment funds are going to firms with a higher marginal return to capital is developed. We examine the relationship between this and various measures of financial liberalization and find that liberalization increases the efficiency with which investment funds are allocated. This holds after various robustness checks and is consistent with firm level evidence that a stronger association between investment and fundamentals after financial liberalization.