Page 289 - ES 2020-21_Volume-1-2 [28-01-21]

272 Economic Survey 2020-21 Volume 1

IS INDIAN INNOVATION AFFECTED BY ACCESS TO FINANCE?

Box 5: Methodology for Estimating Correlation between
Financial Development and Innovation
Hsu, Tian and Xu (2014) observed that industries that are more dependent on external finance, and are
more high-tech intensive, exhibit disproportionally higher innovation in countries with well developed
equity markets. This may be on account of four reasons. Firstly, because there are no collateral
requirements for equity financing, additional equity financing doesn’t increase firms’ probability
of financial distress (Brown, Fazzari, and Petersen, 2009). Secondly, under rational expectations,
equity markets enable investors to extract relevant, but noisy, information from equilibrium prices
(Grossman, 1976; Levine, 2005). Thirdly, as information on the prospects of innovative projects is
either sparse or hard to process, evaluating innovative projects is difficult. Equity markets can facilitate
this evaluation through information embedded in stock market prices (Allen and Gale, 1999). Finally,
equity financing can be particularly well suited for innovative projects that are riskier (Levine, 2005).
New technology stocks can also be priced higher when information about their greater productivity,
but higher uncertainty, reaches stock investors (Pástor and Veronesi, 2009).

On the other hand, Hsu, Tian and Xu (2014) observed that developed credit markets appear to
discourage innovation in industries that are more dependent on external finance and are more high-
tech intensive. This may be on account of two factors. Firstly, innovative firms may have limited
collateral to deploy for debt financing by way of tangible assets, restricting their use of debt (Brown,
Fazzari, and Petersen, 2009). Secondly, risk-averse banks under-invest in high-uncertainty innovative
projects (Stiglitz, 1985). Some studies have found that due to banks’ informational advantages, they
could even inhibit innovation by extracting rents (Hellwig, 1991 and Rajan, 1992).
Based on Hsu, Tian and Xu’s findings, access to equity capital is measured using two indicators:
i. Market capitalisation of listed domestic companies (per cent of GDP)
ii. Venture capital availability rank (based on Venture Capital Availability Index)

Similarly, access to debt capital is measured using the following indicator:
i. Domestic credit to private sector by banks (per cent of GDP)

8.48 Figure 42 examines the performance of top ten economies (GDP current US$) on
innovation with respect to availability of equity finance – market capitalisation of listed domestic
companies (as per cent of GDP) as well as venture capital availability rank. India and Brazil
rank much below expectation for their level of equity market development in the overall GII,
innovation outputs and innovation inputs amongst the top ten largest economies. Given that
most of these large economies are more innovative than India and equity market development
facilitates greater high-technology innovation, this potentially indicates that innovation in India
needs to become more high-tech intensive.