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Financing choice and local economic growth: evidence from Brazil

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Abstract

We study how financing non-traditional local activities, conceived here as a proxy for activity diversification, is associated with economic growth. We use municipality-level data from Brazil, a country with large geographical, social, and economic disparities observed across its more than 5500 municipalities. We find that finance to non-traditional local activities associates with higher municipal economic growth, suggesting a positive externality between the non-traditional and traditional sectors. Using large natural disasters in Brazil as sources of unexpected negative events, we find that this association between financing non-traditional local activities and economic growth becomes negative in times of distress. We find that traditional local sectors are more affected than non-traditional sectors following a natural disaster. Precisely because of the non-traditional sector’s dependence on the traditional sector, our results suggest that municipalities should restrengthen their traditional activities during adverse conditions.

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Notes

  1. See Beck et al. (2014a, 2015), King and Levine (1993), Levine and Zervos (1998) and Rajan and Zingales (1998).

  2. For example, Abedifar et al. (2016) and Andersson et al. (2016) evaluate the contribution of public or private banks to local economic growth.

  3. See Davis and Dingel (2020), who develop a spatial-equilibrium model in which the comparative advantage of municipalities is related to the comparative advantage of individuals and their locational choices. They find that the distribution of activity within municipalities will have richer dynamics than the one offered by a polarized view of specialization versus diversification.

  4. Assume a municipality specialized in agriculture and industrial activities, but with no services facilities. The introduction of services facilities could make a more significant difference than introducing a new factory or a new farm. In the former, returns are much higher due to the municipality’s actual low levels of services.

  5. Notable works in this area include Abedifar et al. (2016), Beck et al. (2000, 2014a, 2014b, 2015), Beck and Levine (2004), Galor and Zeira (1993), Jayaratne and Strahan (1996), King and Levine (1993), Law and Singh (2014), Levine (2005), Levine and Zervos (1998), Rajan and Zingales (1998), Rioja and Valev (2004), Samargandi et al. (2015) and Soedarmono et al. (2017).

  6. These legal/institutional/political confounders are mostly a problem in cross-country studies that exploit cross-sectional variations. Nevertheless, many studies in the finance-growth literature use dynamic panel estimation and control these dimensions using country fixed effects. The issue may arise if these factors are time-varying and correlated with financial development and growth, as is often likely.

  7. The availability of loan-level credit data bounds the lower limit. Municipality-level data on growth and traditional local activities bound the upper limit when writing this paper.

  8. In Brazil, the definition of a municipality is legally equivalent to a city. They encompass both rural and urban areas.

  9. We exclude credit to the public administration and extraterritorial entities with branches located in Brazil, such as foreign diplomatic representations. In this way, we focus on credit to business firms and how it affects local growth. We use the same filtering criteria in the other datasets.

  10. Some municipalities may specialize in more than a single economic activity. We also test how finance to non-traditional local activity is associated with economic growth in municipalities with high and low specialization in a single activity in Sect. 6.1.

  11. Some firms have multiple economic sectors. In this case, we use the economic sector of their headquarters. To get a sense, in 2014, only 0.76% of the firms used in the empirical analysis had multiple economic sectors. These firms are the largest ones and borrowed around 48% of all bank credit that year. We report econometric exercises in which we remove firms with branches and, therefore, with potentially multiple economic sectors.

  12. In Sect. 6.2, we show that the traditional activities of municipalities are long-standing and do not vary much. Also, we run robustness tests by fixing an ex-ante invariant municipality-specific traditional activity. The results remain unchanged.

  13. If the same municipality experiences several natural disasters within a year, we sum up each natural disaster’s losses.

  14. The share of the affected population due to natural disasters roughly follows a power-law distribution. Therefore, the severity of disasters quickly drops. While our results tend to get stronger if we consider the largest disasters, they tend to lose significance when we add more.

  15. Even though we have data from 2003 to 2014, we remove shocks that took place in 2003 and 2014 so that we can have at least one point in the pre- and post-treatment periods for the difference-in-differences analysis.

  16. STR and CIP-Sitraf are real-time gross settlement payment systems that record electronic interbank transactions in Brazil. These are high-frequency datasets that provide information on the transaction’s exact time, the identification and location of the payer and receiver of the money, and the transaction’s purpose, among others. Our analysis removes payments among branches of the same firm conglomerate, as they are likely to increase when a firm branch is experiencing liquidity issues.

  17. In Sect. 6.3, we also add further robustness tests in which we remove these sectors that can benefit from the local government in terms of funding and rerun our empirical specifications. The results remain unchanged.

  18. The Kendall pairwise correlation provides the rank correlation between pairs of variables.

  19. Even though with widespread adoption in the finance-growth literature, the System GMM estimator assumes mean stationarity to derive additional moment conditions (Arellano & Bover, 1995). Roodman (2009) has critically assessed the credibility of mean stationarity in applied economic research. He concludes that such an assumption is not trivial and seems to be underappreciated in applied research. Bun and Sarafidis (2015) suggest using the Ahn et al. (1995) estimator, which introduces additional non-linear moments to the estimation and is robust to deviations from mean stationarity. In unreported results, we also estimate Specification (3) using Ahn et al. (1995) estimator. The results remain qualitatively the same, even though the autoregressive coefficient drops in magnitude to the range of \([-0.219, -0.180]\).

  20. The Sargan–Hansen test can have low power when the number of instruments used is relatively large (Roodman, 2009). Therefore, we reduce the number of instruments as much as possible in our estimations.

  21. Bond et al. (2001) suggest comparing the autoregressive parameter \(\rho \) in Specification (3) estimated using System GMM with the plain OLS and the within-group estimators to detect whether serious finite samples biases are present. OLS estimates will provide an estimate of \(\rho \) that is biased upwards in the presence of individual fixed effects. Within-group estimates will give an estimate of \(\rho \) that is seriously biased downwards in short panels. Therefore, a consistent estimate of \(\rho \) should lie in-between the OLS and within-group estimates. If we rerun the specifications in Table 3 using the plain OLS and within-group estimators, we get autoregressive estimates of \(\rho \) inside the interval \([-0.069, -0.056]\) and \([-0.636, -0.587]\). Our System GMM estimates lie in the interval \([-0.520,-0.476]\) that resides within the plain OLS and within-group estimates. Thus, concerns about finite sample biases are mitigated.

  22. The share of firms with no branch within each economic sector largely varies. For instance, in 2014, the sector “Wholesale and retail trade, repair of motor vehicles and motorcycles” had 2,179,088 different firms borrowing bank credit, of which 82.5% had no branches. The sector “Manufacturing” had 578,661 different firms, of which 76.3% had no branches. In contrast, the sector “Electricity, gas, steam, and air conditioning supply” had 1771 different firms borrowing credit, of which only 29.8% had no branches.

  23. This matching strategy removes widespread natural disasters that enclose entire mesoregions. For instance, most of the heavy rainfalls nearby Amazonian municipalities are extensive, such that there are no candidate municipalities for the control group. These shocks, therefore, are not studied in this paper.

  24. Papaioannou and Siourounis (2008) provides an interesting application of Laporte and Windmeijer (2005)’s method.

  25. Our results complement the findings of Cerra and Saxena (2008) who document a large and persistent output loss associated with financial and political crises. However, we add to this research by showing that unexpected (large) natural disasters—which can be conceived as a local crisis—can also have permanent effects on the economy.

  26. Since \(FNT_{i,s}\) is invariant over time, the term \(Treat_{i,s} \cdot FNT_{i,s}\) is absorbed by the shock-municipality fixed effects. The time difference of \(Post_{s, t} \cdot Treat_{i,s} \cdot FNT_{i,s}\) and \(Post_{s, t} \cdot FNT_{i,s}\) results in \(Treat_{i,s} \cdot FNT_{i,s}\) and \(FNT_{i,s}\), respectively.

  27. We should stress that the level of finance to non-traditional local activities is endogenous to the local economic activity. Therefore, we cannot interpret the interaction term in Specification (6) as a causal effect. For instance, the share of credit going to non-traditional activity is endogenous and may respond quite quickly to differential effects of the disaster across sectors. This effect could probably go in either direction (distressed sectors can either borrow less or need to borrow more).

  28. The year 2002 is the first one in which we have detailed data on municipal value-added in agriculture, industry, and services (IBGE dataset).

  29. The Constitutional Amendment (CA) 15 in 2006 made more rigorous the creation of new municipalities. Despite that, many municipalities were created after that mainly due to financial benefits that municipalities enjoy from compulsory federal government transfers guaranteed by the Federal Constitution. In 2008, another CA came into force and validated those municipalities created after 2006 to end the uncertainty surrounding their legal status. The creation of municipalities after 2010 is facing considerable legal uncertainty, which has been preventing the constitution of new municipalities. One of the main recent requirements is that parties involved in the municipality creation have to show the act’s economic viability, and the population needs to vote and confirm its creation.

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Acknowledgements

We thank Editor Oded Galor for handling the paper’s revision process and the Associate Editor and the two anonymous referees for the insightful comments. Thiago C. Silva (Grant Nos. 408546/2018-2, 308171/2019-5) and Benjamin M. Tabak (Grant Nos. 310541/2018-2, 425123/2018-9) acknowledge financial support from the CNPq foundation. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Banco Central do Brasil

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Authors and Affiliations

  1. Research Department, Banco Central do Brasil, Brasília, DF, Brazil

    Thiago Christiano Silva

  2. Universidade Católica de Brasília, Brasília, DF, Brazil

    Thiago Christiano Silva

  3. Fordham University, New York City, USA

    Iftekhar Hasan

  4. FGV/EPPG Escola de Políticas Públicas e Governo, Fundação Getúlio Vargas (School of Public Policy and Government Getúlio Vargas Foundation), Brasília, DF, Brazil

    Benjamin Miranda Tabak

  5. Bank of Finland, Helsinki, Finland

    Iftekhar Hasan

  6. University of Sydney, Sydney, Australia

    Iftekhar Hasan

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  1. Thiago Christiano Silva
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Silva, T.C., Hasan, I. & Tabak, B.M. Financing choice and local economic growth: evidence from Brazil. J Econ Growth 26, 329–357 (2021). https://doi.org/10.1007/s10887-021-09191-0

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