wages and bankruptcy laws

We study the impact of bankruptcy laws in general equilibrium, taking into account the interactions between the credit and the labor markets, as well as wealth heterogeneity. Soft bankruptcy laws often preclude liquidation in order to avoid ex-post inefficiencies. This worsens credit rationing, depresses investment and reduces aggregate leverage. Yet, tough laws do not necessarily maximize social welfare or emerge from the legislative process. Relatively rich agents, who can invest irrespective of the law, favor soft laws which exclude poorer entrepreneurs from the credit market and thus reduce labor demand and wages. This raises the pledgeable income of the entrepreneurs who can still raise funds, and thus lowers their liquidation rates and the associated inefficiencies. Hence, a soft law can maximize social welfare. Last, a soft bankruptcy law may be a more effective instrument than investment subsidies from a welfarist point of view