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Department of Economics, Lund University Working Papers, Department of Economics, Lund University

No 2006:19:
Industry Diversification, Financial Development and Productivity-Enhancing Investments

Alfredo Schclarek

Abstract: This paper theoretically studies the role of the financial system in promoting macroeconomic stability and growth. It also explains endogenously the development of the financial system as part of the growth process. The productive sector engages in R\&D activities, and finances its activities through access to the financial system. While vertical innovation spurs economic growth, horizontal innovation creates new industry sectors, and thus enhances industry diversification. Higher industry diversification deepens the financial system by improving its ability to finance the productive sector. Economies that are more diversified, and thus more financially developed, have higher growth rates and are less volatile. There is a role for the government to subsidize innovation, especially horizontal innovation.

Keywords: vertical innovation; horizontal innovation; industry diversification; financial development; economic growth; imperfect information; (follow links to similar papers)

JEL-Codes: E22; E32; E44; O16; O30; O41; (follow links to similar papers)

24 pages, September 20, 2006

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