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Legal Institutions, Sectoral Heterogeneity, and Economic Development ∗ (2008)
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@MISC{Castro08legalinstitutions,,
author = {Rui Castro and Gian Luca and Clementi Glenn Macdonald},
title = {Legal Institutions, Sectoral Heterogeneity, and Economic Development ∗},
year = {2008}
}
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Abstract
(Download the most recent version) 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.
Keyphrases
economic development sectoral heterogeneity legal institution investment distortion relative price capital good investment good risk induces first document investor right investor protection idiosyncratic risk cross country dispersion recent version poor country investment rate capital accumulation micro foundation consumption good
