Investment in Relationship-Specific Assets: Does Finance Matter?

We show that contract-intensive industries particularly thrive both in countries with high initial level of financial development and in the US states that deregulated their banking sector. These industries use high share of relationship-specific inputs that can be purchased only via specific contracts with the suppliers. Accordingly, both firms in those industries and their suppliers face above-average levels of risk and transaction costs. Our empirical results thus confirm the theoretical claim that finance promotes real economy via managing risk and decreasing transaction costs. Furthermore, the pro-growth e¤ect of finance seems to come from financial intermediaries like banks rather than from stock markets. This suggests that the intrinsic functions of relationship-banking (long-term commitment, increase in reputation and planning horizon of the borrowers) are especially important for the contract-intensive industries.