Does financial development drive innovation? A two-step system generalized method of moments approach

• Main Authors: Ng, Michaela Wencee S., Wang, Jiajia, Xu, Binbin, Zheng, Sharleen Lu
• Format: text
• Language: English
• Published: Animo Repository 2022
• Subjects: Financial engineering; Technological innovations; Finance and Financial Management; Growth and Development
• Online Access: https://animorepository.dlsu.edu.ph/etdb_econ/44; https://animorepository.dlsu.edu.ph/cgi/viewcontent.cgi?article=1046&context=etdb_econ
• Institution: De La Salle University

With the promising benefits that innovation brings to an economy, it is not surprising that countries are looking for ways to increase innovation activities. When previous studies looked at the ability of financial development to spur innovation in the private sector, the results were inconsistent, and the variables used (credit and stock market capitalization) do not capture other aspects of financial development. This study adds knowledge to existing finance-innovation studies by using the financial institution development and financial market development indices as independent variables to capture financial development not only in terms of credit and capitalization but also in different aspects, such as depth, access, and efficiency. The data were taken across 40 middle-income countries and 37 high-income countries from 1990 to 2018. The DH Granger Non-Causality and two-step system GMM tests were used for the analysis to control for past lags and endogeneity. Treatment for missing values was also applied to the data. The results show that while both the financial institution and financial market development indices are valid instruments in explaining innovation, only financial institution development has significant and positive effects on innovation. This means that financial institutions are more relevant than financial markets when it comes to financing innovation activities, mainly by operating more efficiently and making their credit and financial services accessible to the private sector.