Investor Protection, Optimal Incentives, and Economic Growth

Abstract

Recent empirical evidence has suggested a positive association between various measures of investor protection and financial markets' development, and between financial markets' development and economic growth. We introduce investor protection in a simple extension of the two-period overlapping generations model of capital accumulation and study how it affects economic growth. Investor protection is positively related to risk-sharing. As is standard in models of investment with risk-averse agents, better protection (better risk sharing) results in a larger demand for capital. This is the demand effect. A second effect, which we call the supply effect, follows from general equilibrium restrictions. For a given aggregate capital stock, better protection (i.e. a higher demand schedule) implies a higher interest rate. The aggregate resource constraint then implies lower income for the entrepreneurs (the younger cohort). As a result, current savings and the supply of capital in the following period decrease. It turns out that the strength of the supply effect is greater, the tighter the restrictions on capital flows. Therefore our model predicts that the positive effect of investor protection on growth is stronger for countries with lower restrictions. We find that the data provides some support for this prediction.

Financial Integration, Financial Development, and Global Imbalances

“…This can be interpreted as a fine or additional punishment. A similar assumption is made in Castro, Clementi, and MacDonald (2004) in an environment with information asymmetry.…”

Quantifying the Impact of Financial Development on Economic Development

“…This is separate from regulating the terms of payments, especially in bankruptcy (here p 1 or p 12 ) as analyzed in Castro et al (2004).…”

The effects of credit subsidies on development

“…In this case, financial intermediaries have access to an elastic supply of funds and the interest rate is exogenously given and it is equivalent to the interest rate in the baseline economy, which is roughly 4.47% per year. The difference of the effects of credit subsidies on the economy for the cases in which the interest rate is exogenous or endogenous might be large, as Castro, Clementi, and MacDonald (2004) and Antunes, Cavalcanti, and Villamil (2008b) show that this general equilibrium effect is quantitatively important in the analysis of financial reforms that improve creditors' right.…”

“…Some of these reforms are: improvements in creditors' protection, changes in the bankruptcy law, or a decrease in implicit and explicit taxes on banks, among others. Some recent examples in this literature, which try to quantitatively evaluate the effects of such reforms in macroeconomic models, are: Amaral and Quintin (2010), Antunes, Cavalcanti, and Villamil (2008b), Buera and Shin (2008), Castro, Clementi, and MacDonald (2004), Erosa and Hidalgo-Cabrillana (2008), Greenwood, Sanchez, and Wang (2010), among others. The main finding of this literature is that financial reforms might have sizeable effects on efficiency, development and inequality and the effects are stronger when the economy is financially integrated in the international capital market.…”