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Dr. Julian Neira

University of Exeter, United Kingdom

Author: Julian Neira

Abstract: Income differences across countries are large and mostly accounted for by differences in total factor productivity (TFP). Financial frictions generate misallocation of resources that show up in aggregate measurements as a reduction in TFP. I construct a model in which financial frictions are micro-founded and have a mapping to available micro data - World Bank measures of recovery rates across countries. I calibrate the model to U.S. data, and feed observed recovery rates across countries. I find that the ensuing misallocation of talent generates aggregate TFP differences of 1.5, about a fourth of observed TFP differences. The model features a competitive lender who wants to offer the best contract to entrepreneurs, but faces two constraints. First entrepreneurial ability is unobservable. Second, the lender can only recover a fraction of the initial loan in case an entrepreneur defaults on the terms of the contract, i.e. the recovery rate is less than one. As the recovery rate decreases, the average quality and the total quantity of funded projects decrease, which decreases TFP. The decrease in quality comes from the limited ability to impose penalties on entrepreneurs who misrepresent the quality of their project. This causes lenders to increase the probability that a low-quality project receives funding in order to maintain the truth-telling incentives of low-talent entrepreneurs. The decrease in quantity of projects comes from the lenders limited ability to obtain funds from profitable projects to fund other profitable projects. I also find that complementarities between contract enforceability and aggregate endowments are quantitatively important.

Keywords: Financial Frictions, Misallocation, Total Factor Productivity

JEL No. E44,E23,E02,D24,O47

Full Text:  “Recovery Rate, Misallocation of Talent and Cross-Country Productivity Differences”