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Marginal Product of Capital under Financial Frictions

Margarita Lopez Forero

No 21-03, Documents de recherche from Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne

Abstract: We link the Lucas' Paradox to the interaction between sector and countrylevel financial frictions. First, we compute proper measures of the aggregate marginal product of capital (MPK), accounting for natural capital and relative capital prices, for a panel of 50 developed and developing countries over 1995-2008. Our aggregate MPK measures imply there are little incentives for capital to flow to capital-poor economies over the sample period. Next, we examine how sector and country-level financial frictions interact to shape the aggregate MPK of a country. To do so, we use industry-level data to construct an annual country-level measure of external financial dependence and assess its effects on aggregate MPK conditional on the level of financial development and alternatively, on legal origins, our instrumental variable. We find that external financial dependence positively relates to MPK in developed countries, regardless of their level of financial development while it negatively relates to MPK in developing economies. Financial development appears to be a necessary condition in order for production in financially dependent sectors to positively affect aggregate MPK in developing countries. Our results taken altogether suggest that sector and country level financial frictions act as inefficiencies precluding improvements of MPK in developing economies despite large differences in capital-to-labor rations with respect to developed countries.

Keywords: Financial Dependence; Financial Development; Marginal Product of Capital; Financial Frictions; Legal Origins; Lucas Paradox (search for similar items in EconPapers)
JEL-codes: E22 F11 F21 F32 F41 F63 O11 O16 O47 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2021
New Economics Papers: this item is included in nep-fdg, nep-mac and nep-opm
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