Journal Article

Legal Institutions, Sectoral Heterogeneity, and Economic Development

Rui Castro, Gian Luca Clementi and Glenn Macdonald

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 76, issue 2, pages 529-561
Published in print April 2009 | ISSN: 0034-6527
Published online April 2009 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2008.00528.x
Legal Institutions, Sectoral Heterogeneity, and Economic Development

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  • Macroeconomics: Consumption, Saving, Production, Employment, and Investment
  • Microeconomics
  • Analysis of Collective Decision-making

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Poor countries have lower PPP-adjusted investment rates and face higher relative prices of investment goods. It has been suggested that this happens either because these countries have a relatively lower TFP in industries producing capital goods or because they are subject to greater investment distortions. This paper provides a micro-foundation for the cross-country dispersion in investment distortions. We first document that firms producing capital goods face a higher level of idiosyncratic risk than their counterparts producing consumption goods. In a model of capital accumulation where the protection of investors' rights is incomplete, this difference in risk induces a wedge between the returns on investment in the two sectors. The wedge is bigger, the poorer the investor protection. In turn, this implies that countries endowed with weaker institutions face higher relative prices of investment goods, invest a lower fraction of their income, and end up being poorer. We find that our mechanism may be quantitatively important.

Keywords: D02; D72; E22; E23

Journal Article.  12930 words.  Illustrated.

Subjects: Macroeconomics: Consumption, Saving, Production, Employment, and Investment ; Microeconomics ; Analysis of Collective Decision-making

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