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The Effect of Financial Repression & Enforcement on Entrepreneurship and Economic Development

  • António Antunes


    (Banco de Portugal, Departamento de Estudos Economicos, and Faculdade de Economia, Universidade Nova de Lisboa)

  • Tiago Cavalcanti


    (Departamento de Economia, Universidade Federal de Pernambuco, INOVA, Faculdade de Economia, Universi-dade Nova de Lisboa.)

  • Anne Villamil


    (Department of Economics, University of Illinois at Urbana- Champaign)

This paper studies the effect of financial repression and contract enforcement on entrepreneurship and economic development. We construct and solve a general equilibrium model with heterogeneous agents, occupational choice and two Financial frictions: intermediation costs and financial contract enforcement. Occupational choice and firm size are determined endogenously, and depend on agent type (wealth and ability) and the credit market frictions. The model shows that differences across countries in intermediation costs and enforcement generate differences in occupational choice, firm size, credit, output and inequality. Counterfactual experiments are performed for Latin American, European, transition and high growth Asian countries. We use empirical estimates of each country's financial frictions, and United States values for all other parameters. The results allow us to isolate the quantitative effect of these financial frictions in explaining the performance gap between each country and the United States. The results depend critically on whether a general equilibrium factor price effect is operative, which in turn depends on whether financial markets are open or closed. This yields a positive policy prescription: If the goal is to maximize steady-state efficiency, financial reforms should be accompanied by measures to increase financial capital mobility.

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Paper provided by National University of Singapore, Department of Economics, SCAPE in its series SCAPE Policy Research Working Paper Series with number 0610.

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Length: 33 pages
Date of creation: Mar 2006
Date of revision:
Handle: RePEc:sca:scaewp:0610
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