Estimating Cross-Industry Cross-Country Models Using Benchmark Industry Characteristics

International industry data permits testing whether the industry-specific impact of cross-country differences in institutions or policies is consistent with economic theory. Empirical implementation requires specifying the industry characteristics that determine impact strength. Most of the literature has been using US proxies of the relevant industry characteristics. We show that using industry characteristics in a benchmark country as a proxy of the relevant industry characteristics can result in an attenuation bias or an amplication bias. We also describe circumstances allowing for an alternative approach that yields consistent estimates. As an application, we reexamine the influential conjecture that financial development facilitates the reallocation of capital from declining to expanding industries.