Board of Governors of the Federal Reserve System

March 2014

Finance and Productivity Growth: Firm-level Evidence

Oliver Levine and Missaka Warusawitharana

Abstract:

Using data on a broad set of European firms, we find a strong positive relationship between the use of external financing and future productivity (TFP) growth within firms. This relationship is robust to various measures of financing and productivity, and strengthens as financing costs increase. We provide evidence against a reverse-causality explanation by showing that this relationship arises from the component of TFP that is outside the information set of the firm. These findings indicate that financial development supports productivity growth within firms, and helps explain why economic activity remains persistently depressed following financial crisis.

Keywords: Finance-growth nexus, financial crisis, total factor productivity (TFP)

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