Growth and Activity Diversification: the impact of financing non-traditional local activities

We study how financing non-traditional local activities, conceived here as a proxy for activity diversification, associates with economic growth. We use municipality-level data from Brazil, a country that provides an ideal experimental setup due to the large geographical, social, and economic disparities observed across its more than 5,500 cities. We find that financing non-traditional local activities matters to cities development and such association is stronger at their earlier stages of development. We use the centrality in the network of intercity economic flows as a proxy for the municipality stage of development. The centrality encodes the overall importance of the city in terms of economic intermediation to the entire network structure of business activities. The network is constructed using every observed intercity wire transfers registered in the Brazilian Payments System. Cities more nearby (geographic closeness) and that transact more (economic closeness) with advanced centers have higher growth rates, suggesting the existence of positive spillovers. Economic spillovers are more critical than geographic spillovers for growth. Using natural disasters as sources of unexpected negative events, we also find that the inverted U-shaped association of financial development variables with growth commonly documented in the finance-growth literature breaks down. In addition, the association between financing non-traditional local activities and economic growth becomes negative in times of distress. Our results suggest that cities should restrengthen their traditional activities when adverse conditions befall.