Local Financial Development, Socio-Institutional Environment, and Firm Productivity: Evidence from Italy

This paper investigates the effects of local financial development and quality of socioinstitutional environment on firmÕs productivity in Italy. We argue that social capital, judicial efficiency, and the presence of criminal organizations might impact the real economy through three channels: i) they have a direct impact through the creation of a business environment; ii) they have an indirect impact, as they are among the main determinants of private credit development and lending risk conditions; iii) they might act as constraints to the effects of financial development on the real economy through misallocation of credit to highly profitable investments. We study the Italian case, using firm level data for productivity and taking advantage of the variation in terms of banking sector development, judicial efficiency, and social capital among Italian provinces. After controlling for potential endogeneity, our empirical results confirm that the real effects of financial development are conditional on the quality of socioinstitutional environment. In particular, we find that i) a larger local banking market has higher positive effects on firm productivity when the socio-institutional environment is sufficiently developed; ii) an improvement of lending condition (reduction of lending rates) has higher effects when the socio-institutional environment is not developed. These evidences highlight that an improvement of socio-institutional environment might spur a virtuous cycle.