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Optimal Development Policies With Financial Frictions

Author(s): Itskhoki, Oleg; Moll, Benjamin

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Abstract: © 2019 The Econometric Society 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.
Publication Date: Jan-2019
Citation: Itskhoki, O, Moll, B. (2019). Optimal Development Policies With Financial Frictions. Econometrica, 87 (1), 139 - 173. doi:10.3982/ECTA13761
DOI: doi:10.3982/ECTA13761
ISSN: 0012-9682
EISSN: 1468-0262
Pages: 139 - 173
Type of Material: Journal Article
Journal/Proceeding Title: Econometrica
Version: Final published version. Article is made available in OAR by the publisher's permission or policy.

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