Limited Enforcement, Financial Intermediation, and Economic Development: A Quantitative Assessment*

Abstract

We present a model of economic development where the importance of financial differences caused by limited enforcement can be measured. Economies where enforcement is poor direct less capital to the production sector, and employ less efficient technologies. Calibrated simulations reveal that the resulting effect on output is large. Furthermore, the model correctly predicts that the average scale of production should rise with the quality of enforcement. Finally, we find that the importance of limited enforcement rises with the importance of capital in production.

Impact of the business environment on output and productivity in Africa

“…The solution to this problem has been discussed by Amaral and Quintin (2009). Here, we formulate the problem and discuss a few predictions before turning to the quantitative effects.…”

“…First, it is generally cheaper to use the internal funds to finance capital. Second, Amaral and Quintin (2009) proves that the financially constrained firm will use all their savings to finance capital.…”

“…The model is based on Amaral and Quintin (2009), which quantifies the effects of poor financial development on output and productivity. The framework is a discrete-time overlapping generations model.…”

“…The first four factors are measured as taxes on output and affect all firms uniformly in a country and therefore will not affect capital accumulation. Financial development is modeled as enforcement of contracts similar to Amaral and Quintin (2009). As Amaral and Quintin (2009) has shown, lower enforcement creates tighter borrowing constraint and tighter borrowing constraint leads to smaller production scale and misallocation of capital across production units.…”

“…To quantify the effects of the five dimensions of business environment on African economic development, we introduces the policy distortions highlighted by Restuccia and Rogerson (2008) in the general equilibrium model studied by Amaral and Quintin (2009). In the model, workers are born with a managerial ability and decide wether to operate a business. If they choose to do so, they can either use their own savings or borrow to finance capital for production.…”