Essays in macro and development economics

Thesis: Ph. D., Massachusetts Institute of Technology, Department of Economics, 2017.Cataloged from PDF version of thesis.Includes bibliographical references.The essays in this thesis study the implications of weak financial institutions for economic growth, allocation of resources, and economic development. Methodologically, the essays draw on a broad range of theoretical and empirical tools from both macro and microeconomics. Many currently and previously developing countries have adopted industrial policies that push resources towards certain "strategic" sectors, and the economic reasoning behind such polices is not well understood. In Chapter 1, I construct a model of a production network where firms purchase intermediate goods from each other in the presence of credit constraints. These credit constraints distort input choices, thereby reducing equilibrium demand for upstream goods and creating a wedge between the potential sales ("influence") and actual sales by upstream sectors. I analyze policy interventions and show that, under weak functional form restrictions, the ratio between a sector's influence and sales is a sufficient statistic that guides the choice of production and credit subsidies. Using firm-level production data from China, I estimate my sufficient statistic for each sector and show that it correlates with proxy measures of government interventions into the sector. Using a panel of cross-country input-output tables and sectoral production tax rates, I show that the tax rates for developing countries in Asia also correlate with the model-implied intervention measure. In joint work with Benjamin Roth, Chapter 2 offers a new explanation for why microcredit and other forms of informal finance have so far failed to catalyze business growth among small scale entrepreneurs in the developing world, despite their high return to capital. We present a theory of informal lending that highlights two features of informal credit markets that cause them to operate inefficiently. First, borrowers and lenders bargain not only over division of surplus but also over contractual flexibility (the ease with which the borrower can invest to grow her business). Second, when the borrower's business becomes sufficiently large she exits the informal lending relationship and enters the formal sector-an undesirable event for her informal lender. We show that in Stationary Markov Perfect Equilibrium these two features lead to a poverty trap and study its properties. The theory facilitates reinterpretation of a number of empirical facts about microcredit: business growth resulting from microfinance is low on average but high for businesses that are already relatively large, and microlenders have experienced low demand for credit. The theory features nuanced comparative statics which provide a testable prediction and for which we establish novel empirical support. Using the Townsend Thai data and plausibly exogenous variation to the level of competition Thai money lenders face, we show that as predicted by our theory, money lenders in high competition environments impose fewer contractual restrictions on their borrowers. We discuss robustness and policy implications. Motivated by the explosive growth of microfinance in India and the eventual collapse of the industry following the default crisis in 2010, my joint work with Daniel Green in Chapter 3 provides a theory that explains how institutional weakness in credit markets can fail to stimulate development even when there is ample credit supply. We show that when borrowers lack credible mechanisms to commit not to borrow further from other lenders in the future, not only does the increasing availability of lenders raise the interest rate on loans and reduce the amount of funds that entrepreneurs can borrow, but perversely it is those entrepreneurs with more profitable investment opportunities that will end up raising fewer investments precisely because they have stronger desires to seek out additional lenders in the future. This effect further discourages entrepreneurs from initiating the most efficient and productive endeavors, generating persistent underdevelopment.by Siyuan (Ernest) Liu.Ph. D