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Financial Frictions and the Rule of Law

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  • Ashantha Ranasinghe
  • Diego Restuccia

Abstract

Using cross-country micro establishment-level data we document that crime and lack of access to finance are two major obstacles to business operation in poor and developing countries. Using an otherwise standard model of production heterogeneity that integrates institutional differences in the degree of financial development and the rule of law, we quantify the effects of these institutions on aggregate outcomes and economic development. The model accounts for the patterns across establishments in access to finance and crime as obstacles to their operation. Weaker financial development and rule of law have substantial negative effects on aggregate output, reducing output per capita by 50 percent. Weak rule-of-law institutions substantially amplify the negative impact of financial frictions. While financial markets are crucial for development, an essential precondition to reap the gains from financial liberalization is that property rights are secure.

Suggested Citation

  • Ashantha Ranasinghe & Diego Restuccia, 2018. "Financial Frictions and the Rule of Law," NBER Working Papers 24546, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:24546
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    4. Kumari, Ranpati Dewage Thilini Sumudu & Chen, Shawn Xiaoguang & Li, Bei & Tang, Sam Hak Kan, 2023. "Can land misallocation be a greater barrier to development than capital? Evidence from manufacturing firms in Sri Lanka," Economic Modelling, Elsevier, vol. 126(C).
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    6. Mascarúa Lara Miguel A., 2022. "Imperfect Law Enforcement, Informality, and Organized Crime," Working Papers 2022-16, Banco de México.
    7. Ranasinghe, Ashantha, 2023. "Gender Specific Distortions, Entrepreneurship and Misallocation," Working Papers 2023-1, University of Alberta, Department of Economics, revised 27 Jul 2023.
    8. Diego Restuccia, 2019. "Misallocation and aggregate productivity across time and space," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 52(1), pages 5-32, February.
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    10. Méndez-Vizcaíno, Juan Camilo & Moreno-Arias, Nicolás, 2023. "Constraints or Opportunities?: Labor Informality and Public Investment in Shaping Debt Limits," IDB Publications (Working Papers) 13049, Inter-American Development Bank.
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    14. Merlin, Giovanni Tondin, 2018. "Entrepreneurship, financial frictions and the welfare gains of business cycles," Textos para discussão 484, FGV EESP - Escola de Economia de São Paulo, Fundação Getulio Vargas (Brazil).

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    More about this item

    JEL classification:

    • O1 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • O4 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity
    • O43 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Institutions and Growth
    • O5 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies

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