A mathematical model of economic growth with transaction costs: Time-series evidence from the Italian Mezzogiorno

In this manuscript, the authors develop an extended neoclassical growth model in which transaction costs are decomposed into ex-ante contracting expenditures and ex-post opportunistic losses. The authors’ research aim consists of examining whether differences in transaction costs help explain the persistent income gap between Northern/Central Italy and the less-developed Mezzogiorno and how these frictions shape β- and σ-convergence over time. To accomplish this goal, the authors construct annual regional proxies for total transaction costs and ex-ante contracting expenditures from publicly available Italian regional accounts for 1995-2021 using model-consistent calibration and econometric estimation. Then, the authors estimate two-state Markov-switching regressions for growth (β-convergence) and dispersion dynamics (σ-convergence), allowing structural parameters to differ across macroeconomic regimes. The theoretical results indicate that total transaction costs hinder both β-convergence (especially in the Mezzogiorno) and σ-convergence, as they act like wedges in the capital market. However, expenditure in ex-ante contracting mitigates opportunistic losses. The empirical findings indicate that the South faces higher levels of total transaction costs than the rest of the country. The proposed total transaction costs and ex-ante contracting measures provide a practical monitoring tool for planners and policymakers to quantify institutional frictions and evaluate reforms aimed at reducing contracting and enforcement costs, thereby supporting evidence-based regional development strategies.