Inequality, Industrialization and Financial Structure

Abstract:     
We introduce monitored bank loans and non-monitored tradeable securities as sources of external finance for firms in a dynamic general equilibrium model. Due to frictions arising from moral hazard, access to credit and each type of financial instrument are determined by the wealth distribution. We study the depth of credit markets (financial development) and conditions under which the financial system relies more on either type of external finance (financial structure). Initial inequality is shown to determine financial development, with high inequality preventing developed systems from emerging. A more equitable income distribution as well as larger capital requirements of industry tend to promote a bank-based system. Investment risk promotes a greater reliance on non-monitored sources, while institutional parameters affect the financial structure in intuitively plausible ways. The model's predictions are consistent with historical and recent development experience.

Number of Pages in PDF File: 45

Keywords: Inequality, Industrialization, Financial, Development, Financial Structure, Bank Finance, Market Finance, Credit Frictions

JEL Classification: E44, G20, G30, O15, O16

working papers series