Journal Of The Econometric Society

An International Society for the Advancement of Economic
Theory in its Relation to Statistics and Mathematics

Edited by: Guido W. Imbens • Print ISSN: 0012-9682 • Online ISSN: 1468-0262

Econometrica: Jan, 2019, Volume 87, Issue 1

Optimal Development Policies with Financial Frictions
p. 139-173

Oleg Itskhoki, Benjamin Moll

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.

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Supplemental Material

Supplement to "Optimal Development Policies with Financial Frictions"

This zip file contains the replication files for the manuscript.  It also contains two appendices to supplement the paper.

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