Preferential Credit Policy with Sectoral Markup Heterogeneity

Abstract

Many emerging economies adopt preferential credit policies towards selected sectors. This paper provides an analysis of the economic rationale behind the preferential credit policies in the presence of market imperfections. Using firm-level data, we first empirically establish that sectors with higher markups are also those enjoying preferential credit subsidy. Disciplined by these empirical findings, we develop a multi-sector model featuring sectoral markup heterogeneity and endogenous firm entry and exit. We show that sector-specific preferential credit policies can be used to improve aggregate productive efficiency by reducing sectoral markup dispersion, despite the inefficiency introduced by allowing for less productive firms to enter and survive without exiting. We quantify the effect of preferential credit policy on aggregate TFP through the two opposite channels.

Keywords: preferential credit policy, sectoral markup heterogeneity, capital misallocation, inefficient firm entry and exit