Financial markets and the allocation of capital: the role of productivity
The efficient allocation of credit is a key element for the success of an economy. Traditional measures of allocative efficiency focus on the Q-theory of investment and, in particular, on the elasticity of finance to investment opportunities proxied by firm real value added. This paper introduces a theory-based alternative measure that focuses instead on the elasticity of credit to firm productivity. In doing so, it develops a simple theoretical framework that delivers clear predictions for the elasticity of credit to current and future productivity depending on capital market frictions. When applied to the novel firm-level dataset of the Competitiveness Research Network (CompNet) set up by the EU System of Central Banks, the proposed measure leads to normative statements about the efficiency of credit allocation across the largest Eurozone economies, changing the conclusions that one would reach based on traditional empirical applications of Q-theory.
3 July 2018 Paper Number CEPDP1555
This CEP discussion paper is published under the centre's Trade programme.