Information, Selection and Growth

We study a dynamic model where growth requires long-term investment, and productivity depends on managerial selection. When ability is not ex-ante observable, managerial selection imposes a cost, as managers facing the risk of being replaced tend to choose a sub-optimally low level of long-term investment. We study how this trade-off between selection and investment evolves with the level of development and the availability of information, and its implications for the design of optimal contractual institutions. Our analysis shows that uncertainty increases investment and growth. Productivity, instead, increases with the dispersion of managerial ability and falls with the variance of idiosyncratic shocks (noise). We then study how the trade-off between selection and investment shapes optimal economic institutions. Rigid contractual institutions sacrificing managerial selection may be optimal when information is very noisy, ability is concentrated, returns to investment are high and agents are patient. This might be the relevant case for developing countries. Finally, we illustrate how policies such as trade and financial openness can affect productivity and growth in a novel way, through their impact on managerial selection and investment.