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Optimal development policies with financial frictions

Itskhoki, Oleg and Moll, Benjamin (2019) Optimal development policies with financial frictions. Econometrica, 87 (1). 139 - 173. ISSN 0012-9682

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Identification Number: 10.3982/ECTA13761

Abstract

Is there a role for governments in emerging countries to accelerate economic development by intervening in product and factor markets? To address this question, we study optimal dynamic Ramsey policies in a standard growth model with financial frictions. The optimal policy intervention involves pro-business policies like suppressed wages in early stages of the transition, resulting in higher entrepreneurial profits and faster wealth accumulation. This, in turn, relaxes borrowing constraints in the future, leading to higher labor productivity and wages. In the long run, optimal policy reverses sign and becomes pro-worker. In a multi-sector extension, optimal policy subsidizes sectors with a latent comparative advantage and, under certain circumstances, involves a depreciated real exchange rate. Our results provide an efficiency rationale, but also identify caveats, for many of the development policies actively pursued by dynamic emerging economies.

Item Type: Article
Official URL: https://www.econometricsociety.org/publications/ec...
Additional Information: © 2019 The Econometric Society
Divisions: Economics
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HC Economic History and Conditions
H Social Sciences > HJ Public Finance
H Social Sciences > HD Industries. Land use. Labor
Date Deposited: 06 Nov 2019 16:09
Last Modified: 28 Jul 2020 10:24
URI: http://eprints.lse.ac.uk/id/eprint/102404

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