Financial development and innovation-led growth: Is too much finance better?

• Published in: Journal of international money and finance 2020-02, Vol.100, p.102083, Article 102083
• Main Authors: Zhu, Xiaoyang, Asimakopoulos, Stylianos, Kim, Jaebeom
• Format: Article
• Language: English
• Subjects: Financial development; Growth; Innovation; Threshold effect
• ISSN: 0261-5606
• DOI: 10.1016/j.jimonfin.2019.102083

•Expansion in financial sector would hurt innovation and innovation-led growth.•Countries with higher level of financial development has a lower rate of innovation.•Vanishing effect between finance and innovation transmits to innovation-led growth.•Effect of innovation on growth becomes smaller with developed financial sector.•Using a dynamic panel threshold model, the estimated threshold is around 60% of GDP. We show that the expansion of financial sector may hurt innovative activities and hence the innovation-led growth, using data on 50 countries over the 1990–2016 period. Countries with higher level of financial development are found to have a smaller positive or insignificant effect on innovation. The marginal effect of innovation on growth is a decreasing function of financial development. Using a dynamic panel threshold method we re-examine the possible non-linearity between finance, innovation and growth. We find that innovation exhibits an insignificant effect on output growth when credit to the private sector exceeds a threshold level of about 60% as a share of GDP. These results are not driven by banking crises, the long run effect of 2007–2008 financial crisis, or the ongoing European sovereign debt crisis.