Entry Costs, Financial Frictions, and Cross-Country Differences in Income and TFP

El-hadj Bah and Lei Fang

Working Paper 2010-16a
September 2010 (Revised July 2014)

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This paper develops a model to assess the quantitative effects of entry costs and financial frictions on cross-country income and total factor productivity (TFP) differences, with a primary focus on the interaction between entry costs and financial frictions. The model is calibrated to match the establishment level statistics for the U.S. economy, assuming a perfect financial market. The simulations based on the calibrated model show that entry costs and financial frictions together account for 55 percent and 46 percent of the cross-country variation in output and TFP in the data. Moreover, a substantial portion of the variation is accounted for by the interaction between entry costs and financial frictions. The main mechanism is that financial frictions amplify the effect of entry costs.

JEL classification: O11, O43

Key words: entry costs, financial frictions, GDP per capita, TFP

The authors thank seminar participants in the 2010 Midwest Macroeconomics Meetings, the 2010 Tsinghua Macroeconomics Workshop for Young Economists, the Society for Economic Dynamics Annual Meetings 2010, the Southern Economic Association Annual Meetings 2010, the Australasian Macroeconomics Workshop 2012, the Southern Workshop in Macroeconomics 2012, the CASEE Macroeconomics Reunion Conference 2012, and the Reserve Bank of New Zealand 2011. They are also grateful to the associate editor and two anonymous referees for their valuable comments. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.
Please address questions regarding content to El-hadj Bah, The University of Auckland, 12 Grafton Road, Auckland, New Zealand, e.bah@auckland.ac.nz, or Lei Fang, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, 404-498-8057, lei.fang@atl.frb.org.
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