Does Local Financial Development Matter?
We study the effects of differences in local financial development within an integrated financial market. We construct a new indicator of financial development by estimating a regional effect on the probability that, ceteris paribus, a household is shut off from the credit market. By using this indicator we find that financial development enhances the probability an individual starts his own business, favors entry of new firms, increases competition, and promotes growth. As predicted by theory, these effects are weaker for larger firms, which can more easily raise funds outside of the local area. These effects are present even when we instrument our indicator with the structure of the local banking markets in 1936, which, because of regulatory reasons, affected the supply of credit in the following 50 years. Overall, the results suggest local financial development is an important determinant of the economic success of an area even in an environment where there are no frictions to capital movements.
KeywordsSocial Capital Small Firm Financial Development Credit Market Saving Bank
We thank Orazio Attanasio, Ed Glaeser, Ross Levine, Paolo Mauro, Mitchell Petersen, Raghuram Rajan, Andrei Shleifer, and Nick Souleles for very helpful comments. We also benefited from the comments of participants to seminars at Duke University, International Monetary Fund, NBER Summer Institute 2001 Capital Markets in the Economy Meeting, NBER Corporate Finance Meeting, the University of Chicago Brown Bag lunch, the World Bank, “Macro and Micro Aspects of Economic Geography” Conference (CREI, Pompeu Fabra), “Evolving credit markets and business cycle dynamics” Conference (European University Institute), Fourth Annual Conference on Financial Market Development in Emerging and Transition Economies (Santiago de Chile). Luigi Guiso also thanks the EEC and MURST for financial support. Luigi Zingales also thanks the Center for Security Prices and the Stigler Center at the University of Chicago for financial support.
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