Impact of Financial Development on Industrial R\&D: Evidence from OECD Countries

Kumar, Labesh and Neumann, Rebecca (2026): Impact of Financial Development on Industrial R\&D: Evidence from OECD Countries.

Abstract

Whether financial development promotes industrial innovation depends not just on how developed a country’s financial system is, but on which dimensions of that system are well developed. This paper examines how depth, access, and efficiency of both financial institutions and financial markets shape R&D investment across industries that differ in their reliance on external finance. Using industry-level data from the ISIC Rev. 4 classification across 18 OECD countries from 1995 to 2019, and drawing on the IMF’s multidimensional Financial Development Index, we analyze how country-level financial development measures interact with an industry-level external finance dependence measure to influence R&D intensity measured relative to output and value added. Our findings show that the overall level of financial development matters primarily through depth. In particular, the depth of financial institutions and, to a lesser extent, the depth of financial markets significantly raise R&D intensity in industries that depend more heavily on external funding. Measures of access and efficiency display little systematic effect. The results are strongest within manufacturing industries, where innovation activity is concentrated. These findings highlight the importance of financial structure and, in particular, the scale and capacity of financial intermediation, in shaping the allocation of innovative investment across industries.

• Item Type: MPRA Paper
• Language: English
• Keywords: R&D intensity, financial development, financial institution depth, external finance dependence, innovation
• Subjects: G - Financial Economics > G1 - General Financial Markets > G10 - General; G - Financial Economics > G2 - Financial Institutions and Services > G20 - General; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O16 - Financial Markets ; Saving and Capital Investment ; Corporate Finance and Governance; O - Economic Development, Innovation, Technological Change, and Growth > O3 - Innovation ; Research and Development ; Technological Change ; Intellectual Property Rights > O30 - General

References

Acemoglu, D. (2002). Technical change, inequality, and the labor market. Journal of economic literature, 40(1), 7–72.

Acemoglu, D. (2003). Labor-and capital-augmenting technical change. Journal of the European Economic Association, 1(1), 1–37.

Acemoglu, D. (2008). Introduction to modern economic growth. Princeton university press.

Acemoglu, D. (2025). Nobel lecture: Institutions, technology, and prosperity. American Economic Review, 115(6), 1709–1748.

Acharya, V., & Xu, Z. (2017). Financial dependence and innovation: The case of public versus private firms. Journal of financial economics, 124(2), 223–243.

Aghion, P., Fally, T., & Scarpetta, S. (2007). Credit constraints as a barrier to the entry and post-entry growth of firms. Economic policy, 22(52), 732–779.

Aghion, P., Howitt, P., & Mayer-Foulkes, D. (2005). The effect of financial development on convergence: Theory and evidence. The quarterly journal of economics, 120(1),173–222.

Aghion, P., & Jaravel, X. (2015). Knowledge spillovers, innovation and growth. The Economic Journal, 125(583), 533–573.

Agrawal, A., Rosell, C., & Simcoe, T. (2020). Tax credits and small firm r&d spending. American Economic Journal: Economic Policy, 12(2), 1–21.

Ahlstrom, D. (2010). Innovation and growth: How business contributes to society. Academy of management perspectives, 24(3), 11–24.

Amore, M. D., Schneider, C., & ˇZaldokas, A. (2013). Credit supply and corporate innovation. Journal of financial economics, 109(3), 835–855.

Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte carlo evidence and an application to employment equations. The review of economic studies, 58(2), 277–297.

Arrow, K. J. (1962). The economic implications of learning by doing. The review of economic studies, 29(3), 155–173.

Becker, B. (2015). Public r&d policies and private r&d investment: A survey of the empirical evidence. Journal of economic surveys, 29(5), 917–942.

Bilir, L. K., Chor, D., & Manova, K. (2019). Host-country financial development and multinational activity. European Economic Review, 115, 192–220.

Bloom, N., Griffith, R., & Van Reenen, J. (2002). Do r&d tax credits work? Evidence from a panel of countries 1979–1997. Journal of Public Economics, 85(1), 1–31.

Bloom, N., Van Reenen, J., & Williams, H. (2019). A toolkit of policies to promote innovation. Journal of economic perspectives, 33(3), 163–184.

Braun, M., & Larrain, B. (2005). Finance and the business cycle: international, inter-industry evidence. The journal of finance, 60(3), 1097–1128.

Brown, J. R., Fazzari, S. M., & Petersen, B. C. (2009). Financing innovation and growth: Cash flow, external equity, and the 1990s r&d boom. The journal of finance, 64(1), 151–185.

Carree, M. A., & Thurik, A. R. (2010). The impact of entrepreneurship on economic growth. In Handbook of entrepreneurship research: An interdisciplinary survey and introduction (pp. 557–594). Springer.

Chava, S., & Roberts, M. R. (2008). How does financing impact investment? the role of debt covenants. The journal of finance, 63(5), 2085–2121.

Czarnitzki, D., & Hottenrott, H. (2011). R&d investment and financing constraints of small and medium-sized firms. Small business economics, 36, 65–83.

Czarnitzki, D., & Toole, A. A. (2011). Patent protection, market uncertainty, and r&d investment. The Review of Economics and Statistics, 93(1), 147–159.

David, P. A., Hall, B. H., & Toole, A. A. (2000). Is public r&d a complement or substitute for private r&d? a review of the econometric evidence. Research policy, 29(4-5), 497–529.

Falk, M. (2006). What drives business research and development (r&d) intensity across organisation for economic co-operation and development (oecd) countries? Applied Economics, 38(5), 533–547.

Falk, M. (2012). Quantile estimates of the impact of r&d intensity on firm performance. Small Business Economics, 39, 19–37.

Gao, Y., Zang, L., Roth, A., & Wang, P. (2017). Does democracy cause innovation? An empirical test of the popper hypothesis. Research Policy, 46(7), 1272–1283.

Hall, B. H. (1993). R&d tax policy during the 1980s: success or failure? Tax policy and the economy, 7, 1–35.

Hsu, P.-H., Tian, X., & Xu, Y. (2014). Financial development and innovation: Cross-country evidence. Journal of financial economics, 112(1), 116–135.

Manova, K. (2013). Credit constraints, heterogeneous firms, and international trade. Review of Economic Studies, 80(2), 711–744.

Maskus, K. E., Milani, S., & Neumann, R. (2019). The impact of patent protection and financial development on industrial r&d. Research Policy, 48(1), 355–370.

Maskus, K. E., Neumann, R., & Seidel, T. (2012). How national and international financial development affect industrial r&d. European Economic Review, 56(1), 72–83.

Rajan, R., & Zingales, L. (1996). Financial dependence and growth. National bureau of economic research Cambridge, Mass., USA.

Rajan, R., & Zingales, L. (1998). Financial development and growth. American economic review, 88(3), 559–586.

Romer, P. M. (1986). Increasing returns and long-run growth. Journal of political economy, 94(5), 1002–1037.

Romer, P. M. (1990). Endogenous technological change. Journal of political Economy, 98(5, Part 2), S71–S102.

Schumpeter, J. A. (1942). Capitalism, socialism and democracy. Harper and Row, New York, NY.

Smith, A. (1776). The wealth of nations. Modern Library, 2000.

Solow, R. M. (1956). A contribution to the theory of economic growth. The quarterly journal of economics, 70(1), 65–94.

Swan, T. W. (1956). Economic growth and capital accumulation. Economic record, 32(2), 334 361.

Thomson, R. (2017). The effectiveness of r&d tax credits. Review of Economics and Statistics, 99(3), 544–549.

Varsakelis, N. C. (2001). The impact of patent protection, economy openness and national culture on r&d investment: a cross-country empirical investigation. Research policy, 30(7), 1059–1068.