Credit Frictions, Firm-Level Uncertainty and Long-Run Growth

This paper examines how credit frictions affect the link between firm-level uncertainty and long-run growth in an endogenous growth model. We show that when firms observe idiosyncratic shocks freely, but financial... [ view full abstract ]

This paper examines how credit frictions affect the link between firm-level uncertainty and long-run growth in an endogenous growth model. We show that when firms observe idiosyncratic shocks freely, but financial intermediaries have to incur monitoring costs, higher uncertainty reduces steady-state growth. This occurs because the information asymmetry creates a wedge between the marginal product of capital and its rental rate, which decreases with the degree of credit frictions. Higher uncertainty thus lowers capital accumulation and growth. However, when the information asymmetry is low, as proxied by low bankruptcy costs, the negative effect of idiosyncratic uncertainty on long-term growth tends to vanish. Estimating country-specific dispersion of firms’ sales growth rates for 73 countries as a proxy for firm-level uncertainty,we provide empirical support for this theoretical prediction.