The effects on innovation from financial sector development: Evidence from developing countries

Abstract

The subject of financial system development is widely studied in the finance literature as an indicator of economic growth and a driver of technological innovation supporting the mobilization of capital for growth. However, varying results are obtained when examining developed countries compared to the emerging countries. Developing countries are characterized by a lower investment in innovation, and lower levels of competitiveness in terms of research and development funding, fewer research academic institutions, but also lower incentives for private innovation by enterprises. The purpose of this paper is to examine the relationship between financial development indicators and innovation by analyzing data for 15 developing countries within the time frame of 1996-2016. The financial system is analyzed in two main pillars: credit institutions and equity markets. The number of innovation patent applications is the dependent variable of the study, i.e. as an indicator of a country's innovative performance. The results of the study show that a higher level of crediting by the banking sector will positively affect the number of patent applications. Credit mobilization by other financial intermediaries in the financial system such as equity markets or non-banking institutions show a lower efficiency in boosting innovation activities, resulting in the opposite effects regarding the number of patent applications. Countries with a higher level of education will show more efforts toward innovation and the development of innovative practices. On the other hand, higher competitiveness among companies in terms of technology innovation and processes is expected to boost the demand for funds in the financial system, leading to the improvement in system development.