Market Power and Aggregate Efficiency in Financial Crises

We document that during financial crises in emerging economies, large firms become relatively larger, at the expense of small firms. We claim that this is likely the result of credit constraints that disproportionately affect... [ view full abstract ]

We document that during financial crises in emerging economies, large firms become relatively larger, at the expense of small firms. We claim that this is likely the result of credit constraints that disproportionately affect smaller firms, and analyze the aggregate consequences of the resulting increase in market concentration. We do so in a model where markups are endogenous to the size of the firm and financial frictions take the form of a collateral constraint that gets tighter during a financial crisis. We discipline the model using detailed plant-level microdata for Colombia, and analyze the transition dynamics in response to the 1998/99 credit crunch. We find that the interaction between financial frictions and heterogeneous markup results in non-trivial aggregate dynamics. The fact that firms that become relatively larger with the crisis can increase their markup (and vice-versa), smooths the drop in aggregate output and productivity. Variable markups act as a buffer that partially offsets the misallocation triggered by the financial crises. This follows from adjustments at the intensive margin (i.e. incumbents adjusting their markups), and at the extensive margin, as the entry of low-productivity entrepreneurs in response to the crises is smaller in a model with variable markups.