Financial Frictions, Firm Dynamics and the Aggregate Economy: Insights from Richer Productivity Processes

Juan Carlos Ruiz-García

Janeway Institute Working Papers from Faculty of Economics, University of Cambridge

Abstract: How do financial frictions affect firm dynamics, allocation of resources across firms, and aggregate productivity and output? Is the nature of productivity shocks that firms face primary for the effects of financial frictions? I first use a comprehensive dataset of Spanish firms from 1999 to 2014 to estimate non-parametrically the firm productivity dynamics. I find that the productivity process is non-linear, as persistence and shock variability depend on past productivity, and productivity shocks are non-Gaussian. These dynamics differ from the ones implied by a standard AR(1) process, commonly used in the firm dynamics literature. I then build a model of firm dynamics with financial frictions in which productivity shocks are non-linear and non-Gaussian. The model is consistent with a host of evidence on firm dynamics, financial frictions, and firms' financial behaviour. In the model economy, financial frictions affect the firm life cycle. Without financial frictions, the size of an entrant firm will be three times larger. Furthermore, profit accumulation, which allows firms to overcome financial frictions, is slow, and it only speeds up when firms are mature. As a consequence, the average exiting firm is smaller than it would be without financial frictions. The aggregate consequences of financial frictions are significant. They result in misallocation of capital and reduce aggregate productivity by 16%. This figure is only 8% if productivity dynamics evolve according to a standard AR(1) process.

Keywords: Firm Dynamics; Non-Linear Productivity Process; Financial Frictions; Misallocation (search for similar items in EconPapers)
JEL-codes: E22 G32 O16 (search for similar items in EconPapers)
Date: 2021-08-03
New Economics Papers: this item is included in nep-bec, nep-cfn, nep-cwa, nep-dge, nep-eff, nep-ent and nep-mac
Note: jcrg2
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.janeway.econ.cam.ac.uk/working-paper-pdfs/jiwp2103.pdf

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cam:camjip:2103

Access Statistics for this paper

More papers in Janeway Institute Working Papers from Faculty of Economics, University of Cambridge
Bibliographic data for series maintained by Jake Dyer (jd419@cam.ac.uk).