Legal Institutions, Sectoral Heterogeneity, and Economic Development
by
Rui Castro, Gian Luca Clementi and Glenn MacDonald
Review of Economic Studies, Volume 76, Issue 2, April 2009, pages 529-561
Abstract
Poor countries have lower PPP--adjusted investment rates and face higher
relative prices of investment goods. It has been suggested that this happens
either because these countries have a relatively lower TFP in industries
producing capital goods, or because they are subject to greater investment
distortions. This paper provides a micro--foundation for the cross--country
dispersion in investment distortions. We first document that firms producing
capital goods face a higher level of idiosyncratic risk than their counterparts
producing consumption goods. In a model of capital accumulation where the
protection of investors' rights is incomplete, this difference in risk induces
a wedge between the returns on investment in the two sectors. The wedge is
bigger, the poorer the investor protection. In turn, this implies that countries
endowed with weaker institutions face higher relative prices of investment
goods, invest a lower fraction of their income, and end up being poorer. We
find that our mechanism may be quantitatively important.
Working paper version available
at Repec