Bank development and a lower degree of sophistication and diversification of developing countries’ exports

According to mainstream economic theory, development of the banking sector is essential to fund innovation and technological development, especially in developing countries. In turn, this is expected to cause a shift in comparative advantage towards more sophisticated export goods. Moreover, as financial development relaxes firms’ liquidity constraints, the expectation is that this would result in a greater capacity to export and hence diversification in the export basket. Alternative economic theories are more critical. On the basis of a different conceptualisation of technological advancement which emphasises the centrality of learning and the tacit character of technology, they conclude that financial liberalisation policies would not make more finance available for innovative activities. To the contrary, the main beneficiaries of such policies would be firms employing simpler technologies and making low value added products. Thus, financial development is more likely to prevent an improvement in the degree of sophistication of a country’s export basket. Moreover, as finance is directed towards activities in which the country is already competitive, diversification of the export basket is also hindered. Our empirical analysis provides support for these heterodox theories. Recent empirical work by mainstream researchers also finds that banking sector development forces countries to specialise in accordance with their existing comparative advantage. However, mainstream and heterodox economic theories reach opposite conclusion on whether this is a beneficial process.