the role of financial markets and innovation in productivity and growth … · 2010-11-26 · 1 the...

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The Role of Financial Markets and Innovation in Productivity and

Growth in EuropePhilipp Hartmann, Florian Heider,

Elias Papaioannou, Marco Lo Duca

European Central Bank

United Nations Economic Commission for Europe Conference “Investing in Innovation: Promoting New Opportunities in the UN Economic Commission

for Europe Region”, Geneva, Palais des Nations, 10 April 2008

Disclaimer: This paper is based on internal and external research. Any views expressed are only the authors’ own and should not be regarded as views of the ECB or the Eurosystem or bind them in any form

2

Introduction

• Large academic literature on finance and growth– King & Levine (1993), Rajan & Zingales (1998), Wurgler (2000)

• Complications, esp. from European policy point of view– No distinction between industrialised and developing countries

– Often using historical data

– Often analysing a very narrow issue

• This paper– Adopts a comprehensive view of financial systems

– Chooses from a large number of indicators and most recent data• Updates existing ones

• Introduces new ones

– Focuses on industrial countries and Europe/euro area

– Presents new econometric estimations

– Ambition to inform European policy

3

Elements of the analysis

1) Conceptual framework based on an extensive review of the theoretical and empirical literature on finance and growth– With a particular eye on what works for industrialised countries

2) Compilation of a comprehensive set of indicators of financial development– Embedded in the conceptual framework

– Firmly grounded in the literature

– Comprehensively checked for data quality and comparability

3) Econometric analysis of how financial development affects economic efficiency– Does a more developed financial system help Schumpeterian process

of “creative destruction”, i.e. speed up the reallocation of capital from declining to rising industry sectors?

– What indicators are particularly relevant for this process?

4

Main results

• Total capital market size is a useful summary statistic– Captures overall financial development of an economic region

• Financial market framework conditions could be improved

1) Certain aspects of corporate governance– General shareholder rights have improved in Europe

– But it is still difficult to curb “self-dealing” of corporate insiders

2) Efficiency of legal system in resolving financial disputes– Having many formal steps that regulate legal disputes limits the

supply of capital

3) Structural features of European bank sectors– A small number of countries still have significant levels of

ownership of banks by the public sector

– Do these banks perform better than the average recorded in the literature (e.g. such banks distort competition)?

5

Less strong results

• Information processing capacity of stock markets– Less pricing of idiosyncratic risk and greater uncertainty about

firm prospects in a few specific European countries

• Creditor rights– Bondholders’ say in reorganisations and secured creditors’

priority increases depth and breadth of capital markets

– But the overall strength is still unclear

• Ownership structures– More dispersed ownership of large publicly traded firms and more

institutional shareholders could improve corporate governance

• Financial regulation and supervision– Some aspects could be improved w.r.t. incentives for risk taking

and management

– Moral-hazard of deposit insurance and forbearance discretion

6

Financial system concepts and their interrelation

Financial Stability

Financial Efficiency

Performance of the economy

Performance of the financial system

Fundamentals of the financial system

Market Infrastructures

Economic Stability•Price stability

•Financial Integration•Financial Development /Modernisation

Economic Efficiency•Economic Growth

Other Structural Features

Legal System, Financial Regulation and

Corporate Governance

Monetary Institutions

Financial Structure

7

Size of capital markets

(% of GDP; sum of loans, equity and bonds, BIS, ECB, IMF, Eurostat, WFE)

0%

50%

100%

150%

200%

250%

300%

350%

400%

450%

500%

AT BE DE ES FI FR GR IE IT LU NL PT EA CH SE UK JP US

1990-1994 1995-1999 2000-2005

8

Enforcement of shareholder rights against self-dealing by corporate insiders

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0


(high score = strong rights, anti-self dealing index, Djankov et al. 2006)

9

Duration of enforcement

(calender days, Worldbank, data refer to 2005)

0

200

400

600

800

1000

1200

1400


10

State ownership of banks

0%5%

10%15%20%25%30%35%40%45%50%


1999 2002

(% of total assets, World Bank)

11

Hypothesis

Argument (Bagehot, 1873; Schumpeter, 1911):

In financially developed countries capital flows to industries (as well as firms and entrepreneurs) with positive prospects

Financial Markets Productivity-Innovation (relevance for advanced economies)

Only one broad channel addressed, there are others

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Two-step procedure

1. Estimate country-specific speeds of inter-sectoral capital reallocationUsing industry-level data (in manufacturing), investment growth is regressed on value-added growth (industry prospects).

Control in the estimation for all possible sources of unobservedheterogeneity to precisely isolate the inter-industry response of industry investment to the emergence of growth opportunities (i.e. controlling for specialisation patterns; industry-specific global trends; common sector trends).

2. Examine the effect of capital markets size (financial development) on the estimated speed of capital reallocation and identify the sources of financial development.Two-stage least squares estimation.

Significant refinement of Wurgler (JFE, 2000)

13

Data

• 65 countries – Industrial and developing

– We separate three groups, distinguishing high and low income countries

• 28 manufacturing industries

• 1963 to 2003

• Source: UNIDO, Industrial Statistics Database

14

All Countries

AUS

AUT

BELBGD

BOL

BRB

CAN

CHLCMR

COLCYP

DEUW

DNK

ECUEGY ESP

ETHFINFJI

FRAGBR

GRCGTM

HKG

IDNIND

IRL

IRN ISR

ITA

JOR

JPN

KEN

KOR

KWT

LBYLKA

MAR

MEXMLT

MWI

MYS

NGA

NLDNOR

NZLPAK

PAN

PER

PHL

PRT

SGP

SLV

SWE

SWZ

TTOTUNTUR

TZA

URY

USA

VEN

ZMB

ZWE

-.50

.51

Inve

stm

ent-V

alue

Add

ed G

row

th E

last

icity

(b4)

0 .5 1 1.5Financial Development (FD)

Investment-Growth elasticity estimated:controlling for country, industry, year, country-industry, industry-year and country-year fixed-effects

AUS

AUT

BEL

BRB

CAN

CYP

DEUW

DNK

ESP

FIN

FRAGBR

GRC

HKG

IRL

ISR

ITA

JPNKOR

KWTMLT

NLDNOR

NZL

PRT

SGP

SWE

USA

-.20

.2.4

.6.8

Inve

stm

ent-V

alue

Add

ed G

row

th E

last

icity

(b4)

.4 .6 .8 1 1.2 1.4Financial Development (FD)

Investment-Growth elasticity estimated:controlling for country, industry, year, country-industry, industry-year and country-year fixed-effects

Speed of inter-sectoral capital reallocation and capital markets size: Plots

High Income

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Legal efficiency and capital market size

AUS

AUT

BEL

BOL

BRB

CAN

CHL

COL

CYPDEUW

DNK

ECUEGY

ESPFIN

FRA

GBR

GRC

GTM

HKG

IRLISR

ITA

JOR

JPN

KOR

KWT

LKA MARMEX

MLT

MYSNLD

NORNZL

PAN

PER

PHL

PRT

SGP

SLV

SWE

SWZ

TTO TUN

TUR

URY

USA

VEN

0.5

11.

5Fi

nanc

ial D

evel

opm

ent (

FD)

1 2 3 4 5 6Legal Formalism Index (LEXFORM)

Estimation: Excluding Low Income Countries

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Anti-self dealing and capital market size

AUS

AUT

BEL

BOL

CAN

CHL

COL

DEUW

DNK

ECU EGY

ESP FIN

FRA

GBR

GRC

HKG

IRLISR

ITA

JOR

JPN

KOR

LKA MARMEX

MYSNLD

NORNZL

PAN

PER

PHL

PRT

SGP

SLV

SWE

TUN

TUR

URY

USA

VEN

0.5

11.

5Fi

nanc

ial D

evel

opm

ent (

FD)

0 .2 .4 .6 .8 1Anti Self Dealing Index (ANTISELF)


17

State ownership of banks and capital market size

AUS

AUT

BEL

BOL

CAN

CHL

COL

CYPDEUW

DNK

ECUEGY

ESPFIN

FRA

GBR

GRC

GTM

HKG

IRL

IRN

ISR

ITA

JOR

JPN

KOR

KWT

LBY

LKAMAR MEX

MYSNLD

NORNZL

PAN

PER

PHL

PRT

SGP

SLV

SWE

TTO TUN

TUR

URY

USA

VEN

0.5

11.

5Fi

nanc

ial D

evel

opm

ent (

FD)

0 .2 .4 .6 .8 1Government Ownership of Banks (BGOV)


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Venture capital financing (early investment stage)

(% of GDP, by country of management, EVCA, PWC, Eurostat)

0.00%

0.01%

0.02%

0.03%

0.04%

0.05%

0.06%

0.07%

0.08%

0.09%

0.10%


1995-1999 2000-2005

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Venture capital and innovation

• Generally significant economic effect of VC on innovation– Lerner and Kortum (RAND, 2000) find that in the US over 1983-

1992, VC has accounted for 8% of industrial innovation while being only 3% of R&D investment.

– Da Rin and Penas (NBER, 2007) find that unlike public funding, VC pushes portfolio companies towards more in-house R&D effort.

– However, little effect has been found of VC on Europe‘s most innovative firms‘ ability to raise equity capital, grow and create jobs (Da Rin and Botazzi [CEPR, 2002]), and several case studies show that VC has little impact on the innovation output of European firms (e.g., Peneder [SSRN, 2007] for Austria).

• Interpretation: VC promotes innovation, but only when coupled with available innovative technologies, highly trained workforce, infrastructure, and management expertise, and under the right public policies.

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Public policies promoting VC: Literature

• Taxes– Low capital gains tax is a crucial stimulus to VC investment;

– Tax advantaged stock options most noteworthy change of later years.

• Regulations– Integrated financial services market and a harmonized regulatory

network reduce the cost of capital and widen access to investors;

– Common accounting standards ensure transparency and promote confidence in prospective investors;

– At the same time, too strict anti-trust regulation may create hurdles where no competition issues are raised;

• Labour regulations– Hiring and firing restrictions hamper high-tech VC investments.

• Stock markets targeted at entrepreneurial companies positively affect the share of early stage and high-tech VC investments

21Source: Da Rin et al. (2005), Public policy and the creation of active venture capitalmarkets, ECB WP, no. 430, January.

Share of high-tech investment Share of early-stage investment(i) (ii) (iii) (i) (ii) (iii)

New market 0.090(0.049)*

0.085(0.045)*

0.088(0.046)*

0.087(0.033)***

0.089(0.033)***

0.088(0.033)***

Capital gains tax -0.014(0.003)***

-0.012(0.003)***

-0.015(0.003)***

-0.008(0.002)***

-0.008(0.002)***

-0.008(0.002)***

Per capita publicR&D

-0.004(0.006)

-0.001(0.006)

-0.002(0.006)

0.000(0.005)

0.001(0.005)

0.000(0.005)

Per capita VC funds -0.013(0.039)

-0.011(0.038)

-0.022(0.038)

0.017(0.028)

0.019(0.028)

0.021(0.028)

Last-year‘s per capita VC funds

0.006(0.048)

0.004(0.048)

0.001(0.048)

-0.003(0.035)

-0.000(0.035)

-0.001(0.035)

Aggregate barriersto entry

0.060(0.038)

-0.028(0.027)

Hiring and firingindicator

0.044(0.019)**

-0.009(0.014)

Immigration lawindicator

0.050(0.023)**

-0.002(0.017)

Observations 171 171 171 171 171 171

Panel analysis of VC determinants

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The end

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Securitisation

(% of GDP, by country of collateral, ESF, Eurostat, SIFMA)

0%

5%

10%

15%

20%

25%

30%


2000 2002 2005

24

Pricing of firm-specific information

(R2, high score = less pricing of idiosyncratic risk, own estimations/Datastream)

0

0.1

0.2

0.3

0.4


1990-1994 1995-1999 2000-2004

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Dispersion of analysts’ EPS forecasts

(standard deviation of EPS forecast/level of forecast, Thomson Financial)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

AT BE DE ES FI FR GR IE IT NL PT EA CH SE UK JP US

1990-1994 1995-1999 2000-2004

26

Bank concentration

0

1000

2000

3000

4000

5000

6000


1998 2004

(Herfindahl index for total assets, Bankscope)

27

Supervisory forbearance discretion

(high score = strong discretion, World Bank and ECB)

0

1

2

3

4


1999 2002 2005

28

Empirical approaches

1. Pure Cross-Country Cross-Industry

Fisman and Love (2004a,b); Ciccone and Papaioannou (2006a)

Is industries that experience global investment-growth opportunities growing faster in financially developed countries?

2. Cross-Country (1)Bekaert, Harvey, Lundbald, and Siegel (forthcoming)

Do financially developed countries respond faster to shocks in the industries they specialize in?

3. Cross-Country (II)

Wurgler (2000)

Is industry investment more responsive to output growth (as a proxy for future growth opportunities) in financially developed countries?

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