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Firm Dynamics and Economic Development with Corruption and Financial Frictions

Author

Listed:
  • Simon Alder

    (University of North Carolina at Chapel H)

  • Lin Shao

    (Bank of Canada)

Abstract

We build a firm dynamics model in which the effect of corruption depends on the degree of financial frictions and the stage of economic development. In the model, corruption serves as an endogenous entry barrier that reduces firm churning and protects the incumbent firms, allowing them to accumulate capital quickly and grow out of financial constraints. Corruption can have a positive effect when economic growth relies mainly on capital accumulation. However, as the economy develops, corruption can lead to increasing productivity losses when capital becomes abundant and technological progress becomes the main driver of growth. In addition, more corruption at the early stage could lead to a highly skewed distribution of firms later on, making it easier for asset-rich incumbent firms to bribe government officials and prevent successful innovators from entering the market. We test the predictions of our theory using the Chinese firm-level data from 1998 to 2007. Our theory also has implications for the optimal anti-corruption policy over the development process.

Suggested Citation

  • Simon Alder & Lin Shao, 2019. "Firm Dynamics and Economic Development with Corruption and Financial Frictions," 2019 Meeting Papers 775, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:775
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