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Finance and sources of growth: evidence from the U.S. states

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Abstract

How does financial development affect economic growth: through its impact on accumulation of physical and human capital or by boosting total factor productivity (TFP) growth? We use a new data set on output, inputs, and total factor productivity for the US states to study this question. Unlike previous cross-country research that tries to disentangle the channels through which financial development impacts growth, we use a plausibly exogenous measure of financial development: the timing of banking deregulation across states during the period 1970–2000. At the same time our new data set allows us to go beyond what was previously done in the state banking deregulation literature and identify whether finance impacts states’ input accumulation or TFP growth. We find, in line with existing cross-country studies, that deregulation boosts growth by accelerating both TFP growth and the accumulation of physical capital without having any impact on human capital. In contrast to the cross-country studies, we also find that the effects of deregulation are largely independent of states’ initial level of development; both rich and poor states grow faster after deregulation. Additionally, since our data set breaks down aggregate output into three sectors: agriculture, manufacturing, and the remaining industries, we are able to show that deregulation accelerates the growth of productivity in manufacturing. This last finding answers an important critique of the banking deregulation studies which asserts that observed growth effects may be coming from the growth of financial industry itself and not from the beneficial effect of finance on other industries, such as manufacturing.

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Notes

  1. Many excellent surveys are available (Levine 2005; Demirguc-Kunt and Levine 2008), and therefore, this section will be brief.

  2. There are some indirect results. Black and Strahan (2002) find deregulation had a positive impact on firm entry. Jerzmanowski and Nabar (2013) find that wages of skilled workers increased relative to those in other skilled categories following deregulation.

  3. This is a preferred specification of Turner et al. (2013) and it comes from Valentinyi and Herrendorf (2008).

  4. Black and Strahan (2002) document the dates of deregulation up to 1996. The one additional state that introduced intrastate deregulation after 1996 was Iowa, in 1999 (Beck et al. 2010).

  5. Kroszner and Strahan (1999) find that the share of small banks was related to the likelihood of early deregulation. If for example, this share reflects a state’s legislators’ openness to all kinds of lobbying efforts, which could have other growth-reducing effect, the identification in (3) would be flawed.

  6. Conversely, if states with decelerating growth are more likely to deregulate sooner, perhaps because deregulation is seen as a way to address the growth slowdown, the results would be biased in the opposite direction.

  7. The use of GMM to estimate panel growth regression has become standard approach in the the literature. However, some authors caution against assuming the validity of its underlying assumptions. For example, Hauk and Wacziarg (2009) use a Monte Carlo study to demonstrate that GMM methods significantly overestimate the speed of convergence in panel growth regressions. We report GMM results mainly as a robustness check. In most cases the GMM results are very similar to those obtained using the more conventional methods.

  8. We assigned the low income dummy to states in the bottom 1/3 of the 1970 GDP per worker distribution, the middle to the next 1/3 and so on. The excluded category is high income.

  9. In the “other” sector, the effect is smaller in magnitude, and it is present only when a full set of controls is included in the regressions. The estimates for agriculture are far less conclusive.

  10. In contrast, the “other” sector experiences a significant acceleration in the growth of capital per worker, with point estimates between 0.8 and 1.5 % and uniform statistical significance across all specifications. The effect on agriculture’s capital deepening is again inconclusive.

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Authors and Affiliations

  1. John E. Walker Department of Economics, Clemson University, 222 Sirrine Hall, Clemson, SC, 29634, USA

    Michał Jerzmanowski

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  1. Michał Jerzmanowski
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Correspondence to Michał Jerzmanowski.

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I would like to thank the editor and the anonymous referees for many helpful comments and suggestions. All remaining errors are my own.

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Jerzmanowski, M. Finance and sources of growth: evidence from the U.S. states. J Econ Growth 22, 97–122 (2017). https://doi.org/10.1007/s10887-016-9135-6

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