Need of External Finance and Financial Development: Evidence From Tariff Shocks of Chinese Cities

ABSTRACT This paper explains the variation of financial development at the city level in China from the perspective of the need for external finance. Based on data from 295 prefecture‐level cities from 2003 to 2016, we construct a city‐level measure of external finance need for exports. To address the potential reverse causality, we use tariff data at the city‐product‐destination level exports to establish an instrument for external finance need from tariff shocks. We empirically find that a city's demand for external finance from exports significantly promotes its financial development. In the heterogeneity analysis, we further discover that the positive impact of the external finance need for exports is particularly significant in cities with higher degrees of trade and financial openness, and it is also more pronounced in economically developed cities. Our findings imply that exporting could be an effective way to promote the financial sector for developing countries. JEL Classification: G10, F10, F62.