Financial architecture and industrial technology: A co-evolutionary model

Empirical evidence points to a relation between the financial architecture of an economy and industrial technology: market-based financial systems support the development of industries where innovation is typically radical whereas incremental innovation thrives in association with bank-based finance. I set-up a model where firms choose between either radical or incremental innovation and access external finance either from markets or from a profit-maximizing monopolist bank. In a static environment where all economic agents make optimal decisions, it is the distribution of the firms' heterogeneous ability for radical innovation and other model parameters that uniquely determine the choices made by the firm population and the banker. I run simulations of a dynamic agent-based version of this model, where agents adapt their behavior through reinforcement learning and bankruptcy provides a selection mechanism, to find that this stylized economy is prone to a lock-in phenomenon that can lead the system into different ecologies of technology and finance for the same starting parameters. This shows that co-evolution plays an important part in explaining the observed relation between financial institutions and technology, an important insight for institutional design and reform.