Finally, the stock market capitalization is a measure of the size of equity markets in a country with respect to GDP. This measure has two important advantages: it is comparable with the measure of size of the intermediary sector, and it has been extensively used in comparison to private credit to investigate the effects of financial market structure on economic growth. The main disadvantage of this measure is that it does not contain information about the level of activity of stock markets.<sup>25</sup> The data of the stock market capitalization was also extracted from Beck et al. (2001a).

As previously mentioned, any available measure of financial development is likely to contain a significant amount of measurement error. Intuitively, financial development is broad economic concept whose different aspects can hardly be captured in a single measure: some measures will be just better proxies than others. Moreover, even if only one aspect of financial development is relevant for the mechanism under analysis, idiosyncratic differences across countries can introduce significant amounts of noise. For example, assume that the only relevant aspect of financial development for our mechanism is the ability of firms to obtain short term financing. Even assuming that the ratio of private credit to GDP is a perfect measure of the development of financial intermediaries, the existence of unobservable alternative sources of working capital financing, such as trade credit or large ownership structures, whose importance may vary from country to country, will affect the precision of the measure.<sup>26</sup> In order to address the potential problem of measurement error, the measures of financial development will be instrumented using dummy variables representing a country’s legal origin (English, French, German, or Scandinavian). These instruments, which are standard in the literature of law and finance, were extracted from La Porta et al. (1998) and complemented with data from the World Bank growth network database.

The list of countries used in the analysis and the value of the different measures of financial development for each one of them, is summarized in Table 2. The coverage is better when private credit is used as a measure of financial development because

> 24A criticism that has been raised against the use of accounting standards is that the results obtained when using this measure are highly influenced by a small set of countries at the bottom of the distribution of accounting standards. Even though this is true, this critique is unfair because the information on accounting standards is strongly biased towards developed countries: the sample of countries in which the measure is available includes most of the OECD countries, but only a few developing countries. So, a significant fraction of the variation in the measure of accounting standards is lost when we exclude the few developing countries in the sample.Therefore, it is not surprising to find that the capacity of the variable to identify the effects of financial development is severely reduced when these countries are excluded.

25The results are also not significantly affected when a measure of activity is used instead of stock market capitalization (results not reported).

> 26In particular, an important source of short term credit for firms is the trade credit provided by suppliers. As the relative importance of trade credit may vary from one country to another for reasons unrelated to the development of financial intermediaries, the measure of financial development will only capture part of the story. The same is true for firms that belong to a holding firm, and have access to a pool of resources that is managed without the intervention of intermediaries.

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