The growth accounting literature attribute to differences in aggregate total factor productivity (TFP) as the main source of the large variation on income across countries. There is a growing literature that emphasizes the importance of factor reallocation for TFP and output growth (see-Olley and Pakes (1996), Foster et al. (2006),Griliches and Regev (2006), Bartelsman et al. (2004), Aghion and Howitt (2006)).
Among the factors that drive resource reallocation are technological adoption by incumbents and rm dynamics, ie: entry, growth post entry and exit of non productive firms. Two key factors that have been emphasized as barriers to entry are administrative costs for creating new firms (Djankov et al. (2002)) and product and labor market regulation (Lewis (2004), Fang (2009)), Parente and Prescott (1994),Herrendorf and Teixeira (2009)). There is also a vast literature that examines the link between financial development and economic development. Low financial development is negatively correlated with GDP per capita and TFP.
This paper develops a general equilibrium model to analyze the e ects of high entry barriers and low financial development on aggregate TFP and GDP per capita. The framework is the rm dynamics model of Hopenhayn (1992) and Hopenhayn and Rogerson (1993). Incumbents rms receive productivity shocks and make investment decisions every periods. Investment is financed by retained earnings and external financing.
External nancing is obtained through one-period debt. In the case that the borrower is unable to pay the lender can liquidate the rm. However, in the liquidation process only a fraction of non-depreciated capital can be saved. Therefore, the debt is constrained by the maximum of non depreciated future capital that can be recovered. Also, firms can enter each period by paying entry cost which is nanced by borrowing.
Credit Constraints and Firm Dynamics