the private sector. As shown in Table 1, there is considerable variation in private credit/GDP (the variable PvtCredit) across the countries in my sample; it ranges from a low of 0.04 in Kyrgyzstan to a high of 1.4 in Portugal, and the median country in the sample has a private credit/GDP value of 0.35. As alternatives to private credit/GDP, I use two other measures of a country’s financial development: deposit accounts (Deposit) and the interest rate spread (Spread ). The variable Deposit is the number of bank deposit accounts in a country. These include all checking, savings, and time deposit accounts for businesses, individuals, and others. This variable is taken from the World Development Indicators, where it has been compiled from surveys of banking and regulatory institutions by the World Bank. Spread is the difference between the interest rate charged by banks on loans to prime customers and that paid by banks on demand, time, or savings deposits. The source of the private credit and the interest rate data are the IMF International Financial Statistics.<sup>8</sup> Private Credit/GDP includes credit extended by all banks and non-bank financial institutions. The number of deposit accounts excludes financial intermediaries that do not take deposits, and so is more indicative of just banking sector coverage. The interest rate spread is a measure of the efficiency with which the banking sector intermediates funds; a narrow interest rate spread thus indicates a higher level of financial development. However, it is possible for the banking sector to have limited coverage and a low interest rate spread.<sup>9</sup> So, the three variables pick up closely related but not quite identical aspects of financial intermediation.<sup>10</sup> Table 3 shows that PvtCredit and Deposit are positively correlated, and as expected, Spread has a negative correlation with both variables. Since data on Deposit and Spread is missing for many countries in the sample, estimations using these measures are best viewed as robustness checks.<sup>11</sup> I use two alternative measures of a country’s stock market development, also derived from the World Development Indicators. The variable Stock is the total value of stocks traded in an economy, a measure of the size of stock markets. The second measure is the “turnover ratio” (TRatio), the ratio of stocks traded to stock market capitalization, and it measures stock market liquidity. TRatio ranges from a low of 0.3 to a high of 255 in the data. The two stock market measures are positively correlated with PvtCredit, but the correlation is less than 0.5.

# 2.3 Financial Dependence

I use the Rajan and Zingales (1998) measure of an industry’s dependence on external finance to see if the association between financial development and relative R&D by small firms is stronger in industries that use more external finance. Rajan and Zingales identified an industry’s need for external finance, defined as the difference between investments and cash generated from operations, from data on U.S. firms. Under the assumption that capital markets in the United States are relatively frictionless,

> 8The units of these country-level variables were chosen to make magnitudes comparable. For example, Deposit is measured in units of 10 millions, while PvtCredit is the ratio of private credit to GDP, both measured in the same unit. This makes the magnitude of coefficients comparable across alternative measures of financial development.

> 9Moreover, the interest rate spread measures efficiency under the assumption that interest rates are unregulated.

> 10Also note that being market equilibrium outcomes, they are imperfect measures of the “supply” side of finance.

> 11Results with respect to PvtCredit are not sensitive to limiting the sample to countries with full Deposit and Spread data.

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