Financial Liberalization, Credit Market Dynamism, and Allocative Efficiency

We investigate the effects of financial liberalization on the dynamism of the credit market, as measured by the intensity of credit reallocation across firms. We construct measures of inter-firm credit reallocation in the U.S. states following a methodology akin to Davis and Haltiwanger (1992). We then exploit the staggered deregulation of the credit markets of the states of the eighties as a natural experiment to identify an exogenous shock to the process of credit reallocation. The analysis reveals that the credit market liberalization intensified inter-firm credit reallocation in the states, even within narrowly defined groups of continuing firms, while leaving aggregate credit growth essentially unaltered. The results suggest that, in turn, the increased allocative dynamism of the credit market enhanced the allocation of funds to more productive firms and the TFP growth of the states.