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Does Economic Diversification Lead to Financial Development? Evidence From topography

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  • Rodney Ramcharan

Abstract

An influential theoretical literature has observed that economic diversification can reduce risk and increase financial development. But causality operates in both directions, as a well functioning financial system can enable a society to invest in more productive but risky projects, thereby determining the degree of economic diversification. Thus, ordinary least squares (OLS) estimates of the impact of economic diversification on financial development are likely to be biased. Motivated by the economic geography literature, this paper uses instruments derived from topographical characteristics to estimate the impact of economic diversification on the development of finance. The fourth estimates suggest a large and robust role for diversification in shaping financial development. And these results imply that, by impeding financial sector development, the concentration of economic activity common in developing countries can adversely affect financial and economic development.

Suggested Citation

  • Rodney Ramcharan, 2006. "Does Economic Diversification Lead to Financial Development? Evidence From topography," IMF Working Papers 06/35, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:06/35
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    Cited by:

    1. Nathan Nunn & Diego Puga, 2012. "Ruggedness: The Blessing of Bad Geography in Africa," The Review of Economics and Statistics, MIT Press, pages 20-36.
    2. Hattendorff, Christian, 2015. "Economic concentration and finance: Evidence from Russian regions," BOFIT Discussion Papers 18/2015, Bank of Finland, Institute for Economies in Transition.
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    4. Jaimovich, Esteban, 2011. "Sectoral differentiation, allocation of talent, and financial development," Journal of Development Economics, Elsevier, vol. 96(1), pages 47-60, September.
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    6. KAMGNA, Severin Yves, 2007. "Diversification économique en Afrique centrale : Etats des lieux et enseignements
      [Economic diversification in central Africa]
      ," MPRA Paper 9602, University Library of Munich, Germany.
    7. repec:bof:bofitp:urn:nbn:fi:bof-201505201212 is not listed on IDEAS
    8. Camilleri, Silvio John & Falzon, Joseph, 2013. "The Challenges of Productivity Growth in the Small Island States of Europe: A Critical Look of Malta and Cyprus," MPRA Paper 62489, University Library of Munich, Germany.

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    Keywords

    Financial systems; Financial sector; Economic growth; Financial development; diversification; geography; land area; statistic; heteroscedasticity; standard deviation;

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