Dispersion in Financing Costs and Development

We study how dispersion in financing cost and financial contract enforcement affect entrepreneurship, firm dynamics and productivity. We use employee-employer administrative linked data combined with data on financial transactions of all formal firms in Brazil to show how interest rate spreads vary with firm size, age, among other characteristics. We present a general equilibrium model with endogenous occupational choice based on a modified version of Buera, Kaboski, and Shin (2011), which are consistent with those facts of the credit market. We then provide evidence on the allocative effects of financial reforms. Eliminating dispersion in financing cost leads to more credit and higher output due to cheaper credit for productive agents with low assets. In addition, abstracting from heterogeneity in interest rate spreads understates the impacts of financial reforms that improve the enforcement of credit contracts.

Joint with T. Cavalcanti, J. Kaboski and B. Martins.