Abstract: We propose a theory in which capital market imperfections are at the origin
of cross-country TFP differences. In our theory entrepreneurs have private
information about the multifactor productivity of their technology. We study
how the contracting environment, as described by the ability to enforce
contracts, affects the provision of incentives and resource allocation to
and across entrepreneurs. Our theory implies that countries with a low
ability to enforce contracts use inefficient technologies in equilibrium and
are characterized by differences in productivity across industries. These
implications of our theory are supported by the empirical evidence. Our
theory also suggests that entrepreneurs have a vested interest in
maintaining a status quo with low enforcement since it allows them to
extract rents from the factor services they hire.
Keywords: Capital market imperfections; Total factor productivity, Relative price distortions; Taxation.
JEL Classification: O40;O16;J24;D24