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Legal Institutions, Sectoral Heterogeneity, and Economic Development

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  • CASTRO, Rui
  • CLEMENTI, Gian Luca
  • MACDONALD, Glenn

Abstract

Poor countries have lower PPP–adjusted investment rates and face higher relative prices of investment goods. It has been suggested that this happens either because these countries have a relatively lower TFP in industries producing capital goods, or because they are subject to greater investment distortions. This paper provides a micro–foundation for the cross–country dispersion in investment distortions. We first document that firms producing capital goods face a higher level of idiosyncratic risk than their counterparts producing consumption goods. In a model of capital accumulation where the protection of investors’ rights is incomplete, this difference in risk induces a wedge between the returns on investment in the two sectors. The wedge is bigger, the poorer the investor protection. In turn, this implies that countries endowed with weaker institutions face higher relative prices of investment goods, invest a lower fraction of their income, and end up being poorer. We find that our mechanism may be quantitatively important.

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Bibliographic Info

Paper provided by Centre interuniversitaire de recherche en économie quantitative, CIREQ in its series Cahiers de recherche with number 09-2009.

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Length: 51 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:mtl:montec:09-2009

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Keywords: Macroeconomics; Investment Rate; Overlapping Generations; Relative Prices; Investor Protection; Optimal Contracts;

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  1. Diego Restuccia, 2004. "Barriers to Capital Accumulation and Aggregate Total Factor Productivity," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(1), pages 225-238, 02.
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  5. Shleifer, Andrei & Wolfenzon, Daniel, 2002. "Investor protection and equity markets," Journal of Financial Economics, Elsevier, vol. 66(1), pages 3-27, October.
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  7. Aghion, P. & Howitt, P., 1990. "A Model Of Growth Through Creative Destruction," DELTA Working Papers 90-12, DELTA (Ecole normale supérieure).
  8. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1997. "The poverty of nations: a quantitative exploration," Staff Report 204, Federal Reserve Bank of Minneapolis.
  9. Bronwyn H. Hall, 1988. "The Relationship Between Firm Size and Firm Growth in the U.S. Manufacturing Sector," NBER Working Papers 1965, National Bureau of Economic Research, Inc.
  10. Rui Castro & Gian Luca Clementi & Glenn MacDonald, 2004. "Investor Protection, Optimal Incentives, and Economic Growth," The Quarterly Journal of Economics, MIT Press, vol. 119(3), pages 1131-1175, August.
  11. Heston, Alan & Summers, Robert, 1988. "What We Have Learned about Prices and Quantities from International Comparisons: 1987," American Economic Review, American Economic Association, vol. 78(2), pages 467-73, May.
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