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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 more than 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, 2016. "Financial Frictions and the Rule of Law," Working Papers tecipa-554, University of Toronto, Department of Economics.
  • Handle: RePEc:tor:tecipa:tecipa-554
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    References listed on IDEAS

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    Cited by:

    1. Jeremy Greenwood & Juan Sanchez & Cheng Wang, 2013. "Quantifying the Impact of Financial Development on Economic Development," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(1), pages 194-215, January.
    2. repec:bpj:bejeap:v:17:y:2017:i:4:p:17:n:14 is not listed on IDEAS
    3. Oguzoglu Umut & Ranasinghe Ashantha, 2017. "Crime and Establishment Size: Evidence from South America," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 17(4), pages 1-17, October.

    More about this item

    Keywords

    misallocation; establishments; financial frictions; rule of law; crime; micro data.;

    JEL classification:

    • O1 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development
    • O4 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity

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