Access to External Finance and Innovation: A Macroeconomic Perspective

This article takes a macroeconomic perspective in studying innovation as one of the channels by which better access to financial markets affects economic development. The GMM difference and system estimators which accommodate country specific heterogeneity, endogenous explanatory variables and measurement errors are used to study a panel of 76 countries from year 1988 to 2010. It is found that better access to external finance is a significant factor positively and rapidly influencing innovation and hence long-run economic growth. This positive effect on innovation is robust to both bank and capital market lending with the adverse effect of reduced access to finance on innovation felt disproportionately by lower income countries. However, the estimations suggest that the magnitude of the bank as opposed to capital market lending channel is greater. Moreover, an analysis of the recent financial crisis reveals that the lack of liquidity had a large role to play in reduction of innovation post-crisis.