Financial Market Im ~ erfections and Productivity Growth

Joseph E. Stiglitz Stanford University Stanford, CA This paper examines the impact of financial market imperfections on long-tenn productivity growth. It focuses on failures in markets for the sale of equity securities and hence on the failure of markets which help finns diversify the risks of real investment. The paper examines separately situations in which productivity growth is driven by learning-by-doing and where it results from the cumulative impact of explicit investments in technology by finns. In general, a multiplicity of steady-state growth paths exists with different growth rates along each path. The particular path followed by any single economy (and hence the growth rate of that economy) wiil depend significantly on policy interventions which mitigate effects of financial markets. Introduction This paper investigates the impact of financial markets on long run technological development. The classical approach to such a question centered on the role of financial markets in determining the level of interest rates and the impact of interest rates on investments of all kinds, including investments in research and development. With perfectly informed and competitive financial markets, interest rates are determined by the interaction of real household savings decisions and firm investment decisions. Thus, in the strictest classical (and new classical) tradition, financial markets play no role indetermining the rate of technological development except in so far as they influence transactions costs in transferring funds from lender households to investor firms. However, international and interfinn differences in productivity growth which appear to be related to differences in institution al financial structures raise doubts about this simple classical description of the problem. Moreover, real financial markets appear to differ substantially from the neoclassical norm, being characterized by a wide range of information al imperfections. l This paper, therefore, concentrates on the impact of informational imperfections markets on investment in productivity improvements. As a typical example, it examines the consequences of a situation in which the owner/managers of firms are better informed about their firms' future prospects than participants in financial markets at large. Under these circumstances, as demonstrated by Leland and Pyle [1976], Stiglitz [1982], Myers and Majluf [1984] and Greenwald, Stiglitz and Weiss [1984], markets for the sale of equity shares in firms will function only imperfectly and firms will be constrained in the amounts of equity capital that they can raise. Since l See Greenwald and Stiglitz [1986].