Journal Article

OPTIMAL DEVELOPMENT POLICIES WITH FINANCIAL FRICTIONS

Moll, Benjamin, Itskhoki, Oleg

2019

Overview

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.

• Publisher: Econometric Society,Blackwell Publishing Ltd
• Subject: Accumulation / collateral constraints / Comparative advantage / Depreciation / Development policy / Economic development / Economic factors / Economic models / Foreign exchange rates / Growth models / Industrial and development policies / Labor productivity / Markets / Productivity / Profits / Public finance / Ramsey‐optimal policies / stage dependence / transition dynamics / Wages & salaries / Wealth