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How do firm-specific actions - in particular, innovation - affect firm productivity? And what is the role of the financial sector in facilitating higher productivity? Using a rich firm-level dataset, the author finds that innovation is crucial for firm performance as it directly and measurably increases productivity. Moreover, its effects on productivity are mediated through the financial sector; firms reap the maximum benefits from innovation in countries with well-developed financial sectors. This effect is particularly important for firms in high-tech sectors, which typically have higher external financing needs.
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