Legal Institutions, Sectoral Heterogeneity, and Economic Development

Rui Luís de Castro (), Gian Luca Clementi () and Glenn MACDONALD

Cahiers de recherche from Universite de Montreal, Departement de sciences economiques

Abstract: 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.

Keywords: Macroeconomics; Investment Rate; Overlapping Generations; Relative Prices; Investor Protection; Optimal Contracts (search for similar items in EconPapers)
JEL-codes: E22 F43 G32 G38 O16 O17 O41 (search for similar items in EconPapers)
Date: 2009
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Related works:
Journal Article: Legal Institutions, Sectoral Heterogeneity, and Economic Development (2009)
Working Paper: Legal Institutions, Sectoral Heterogeneity, and Economic Development (2009)
Working Paper: Legal Institutions, Sectoral Heterogeneity, and Economic Development (2007)
Working Paper: Legal Institutions, Sectoral Heterogeneity, and Economic Development (2005)
Working Paper: Legal Institutions, Sectoral Heterogeneity, and Economic Development (2004)
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