Co-integration between Capital Allocation and Financial Development Based on Jiangsu Province

This paper tries to unfold the linkage between capital allocation and financial development by undertaking a co-integration analysis for Jiangsu Province between 1995 and 2007. Following Jeffrey Wurgler´s model, this paper proposes a panel data model to measure the efficiency of capital allocation. Using the data of 37 industries in Jiangsu Province between 1995 and 2007, we find that the average capital allocation efficiency is .4844, which is higher than Shandong province over the period 1993-2005 and the whole country in 1990s. The co-integration analysis shows that capital allocation and financial development are co-integrated. This means that there is a (possibly bi-directional) causality relationship between the two. We establish that there is a unidirectional causality running from financial development to capital allocation indicating that financially developing would promote capital allocation in Jiangsu.