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Distance to frontier and optimal financial structure

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  • Lin, Justin Yifu
  • Wang, Wei
  • Xu, Venite Zhaoyang

Abstract

This paper studies endogenous change of financial institutions in a Schumpeterian endogenous growth model with uncertain innovation outcome. Technological progress can result from either imitation or innovation. Information about each innovative project can be acquired by paying a fixed cost. Financial intermediaries save the information cost through delegation yet incur an agency cost that results from diversity of opinion. Investors thus face a tradeoff between the information and agency cost. Because the information and agency cost is proportional to the technological frontier and the local technology level respectively, saving the information cost dominates in the early stages of development when the distance to frontier is large. In contrast, avoiding the agency cost dominates as the local technology level approaches the frontier. As a result, economic development is accompanied by a gradual switching of financial structure from intermediaries to markets.

Suggested Citation

  • Lin, Justin Yifu & Wang, Wei & Xu, Venite Zhaoyang, 2022. "Distance to frontier and optimal financial structure," Structural Change and Economic Dynamics, Elsevier, vol. 60(C), pages 243-249.
    • Handle: RePEc:eee:streco:v:60:y:2022:i:c:p:243-249
    DOI: 10.1016/j.strueco.2021.12.001
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    Cited by:

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    2. Guo, Wen & Yang, Bo & Ji, Jiong & Liu, Xiaorui, 2023. "Green finance development drives renewable energy development: Mechanism analysis and empirical research," Renewable Energy, Elsevier, vol. 215(C).

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    More about this item

    Keywords

    Distance to frontier; Diversity of opinion; Financial intermediaries; Financial markets; Schumpeterian growth model;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L16 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Industrial Organization and Macroeconomics; Macroeconomic Industrial Structure
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives
    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes
    • O4 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity

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