Increasing Wealth and Increasing Instability: The Role of Collateral

Abstract

In development economics, growth in credit is generally associated with faster long run growth as financial intermediation improves the efficiency of channelling capital to productive investment. Yet, among developing countries high growth in credit almost always guarantees the outbreak of a financial crisis. We attempt to reconcile the two seemingly contradictory facts with an endogenous growth model in which entry to international borrowing entails some significant fixed cost. The poorest countries are excluded from international borrowing because of the fixed cost. The higher income developing countries will find it optimal to sink the fixed cost to borrow internationally, growing faster as a result but also become prone to fluctuations arising from shocks to the international financial market.

Keywords: endogenous growth, borrowing constraint, finance and development, Asian crisis

JEL Classification: E32, O16, O41, O53