Financial Development, R&D and Knowledge Production: Empirical Evidence from China

This paper intends to assess the drivers of knowledge creation in emerging countries. Specifically, the study empirically investigates the long-run impact of financial development, research and development (R&D) activities and the protection of intellectual property rights on knowledge production in China using the ARDL bounds testing approach during the 1979–2018 period. The study also assesses the impact of financial development on knowledge production via its interaction with financial regulations, trade openness and human capital. We measure knowledge capital stock and R&D capital stock using the perpetual inventory flow method assuming different rates of depreciation, while the financial development is measured by conducting the principal component analysis (PCA) of three key banking sector indicators including credit to the private sector to GDP ratio, the ratio of the liquid liabilities to GDP and the sum of commercial bank and central bank assets. Results show that financial development, R&D activities and patent protections are important determinants of knowledge creation in China. Further, estimates reveal that improvements to financial regulations, increased freedom to trade and the level of tertiary education moderate the effect of financial development on knowledge production. The results are robust to several control variables such as the macroeconomic environment of the economy, trade openness, foreign direct investment and knowledge accumulation in the rest of the world. The findings of the paper suggest that the steps taken to develop the financial sector and accelerate R&D activities may contribute to the accumulation of new ideas and stock of knowledge in emerging countries. Furthermore, the study emphasizes prudent financial regulations, trade freedom and improved access to tertiary education to enhance the effect of financial development on knowledge production.