Financial Development and Financing Constraints : International Evidence from the Structural Investment Model

Microeconomic evidence from 40 countries shows that financial development aids growth by reducing financing constraints that would otherwise restrict efficient firm investment.The relationship between the financial and real sides of the economy has long been a topic of intense interest and debate. Love provides microeconomic evidence that financial development aids growth by reducing financing constraints that would otherwise restrict efficient firm investment.The author estimates a structural model based on the Euler equation for investment using firm-level data from 40 countries. The results show a strong negative relationship between the extent of financial market development and the sensitivity of investment to the availability of internal funds (a proxy for financing constraints).Considering size effects, business cycles, and the legal environment as plausible alternative explanations, the author finds the results to be robust in all cases.This paper - a product of Finance, Development Research Group - is part of a larger effort in the group to study the determinants of access to finance. The author may be contacted at ilove@worldbank.org