Banks as Catalysts of the Big Push

Marco Da Rin and Thomas Hellmann ()

No 98, Working Papers from IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University

Abstract: A literature has developed to substantiate Rosenstein-Rodan's intuition that coordination of a critical mass of investments may induce industrialization through a 'big push'. This literature has essentially ignored the question of what economic institutions may overcome the coordination failures which give rise to an 'underdevelopment trap'. In this paper we propose that banks may act as a 'catalyst' for the 'big push'. Our work is motivated by historic evidence that suggest an association between a 'big push' and the emergence of large banks. We develop a model based on Murphy, Shleifer and Vishny (1989) and show that a 'large' bank with sufficient market power can induce the 'big push' by coordinating the investments of a subset of firms in the economy. This creates a critical mass of demand that induces other firms to invest as well. A bank may coordinate firms directly, but more importantly indirectly, that is through the terms of its loans, offering either a low interest rate or investment guarantees. We also show that a overnment might in principle improve on the private market outcome (by subsidizing a bank's coordination activities), but that problems of incentives, credibility and dynamic efficiency makes this difficult.

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