Limited Liability, Growth and Welfare in a Small Open Economy
This paper examines the time path of consumption and asset ownership in a small open economy. Productive physical capital is borrowed when limited liability firms write debt contracts with foreign lenders. We study three lending regimes and find that when contracts favor domestic agents over foreign lenders, welfare is often higher despite a significant reduction in the level of foreign lending. Consistent with the data, the model predicts a hump-shaped pattern of Net Income Payments Abroad. Lastly, under the regime less attractive to foreign investors, the small open economy exhibits transitional dynamics isomorphic to those of the standard neo-classical closed economy
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