Finance and Development: A Tale of Two Sectors

Francisco J. Buera
Joseph Kaboski
Yongseok Shin
Publication Type: 
Papers
Journal Name: 
American Economic Review
Journal Volume: 
101
Journal Number: 
5
Pages: 
1964-2002
Publication Year: 
2011

Income differences across countries primarily reflect differences in total factor productivity (TFP). More disaggregate data suggest that the TFP gap between rich and poor countries varies systematically across industrial sectors of the economy. For example, less developed countries seem particularly unproductive in manufacturing. We develop a quantitative framework to explain the relationship between aggregate/sector-level TFP and financial development across countries. Financial frictions distort the allocation of capital and talent across production units, adversely affecting measured productivity. In our model, sectors with larger scales of operation (e.g., manufacturing) have more financing needs, and are hence disproportionately vulnerable to financial frictions. Our quantitative analysis shows that financial frictions account for a substantial part of the observed cross-country differences in output per worker, aggregate TFP, sector-level relative productivity, and capital to output ratios.

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JEL Codes: 
E44, O11, O16 , O41
Topic: 
Economic Modeling
Topic: 
Financial Institutions
Topic: 
Occupational Choice
Topic: 
General Equilibrium
Topic: 
Growth