ENTRY COSTS, FINANCIAL FRICTIONS, AND CROSS-COUNTRY DIFFERENCES IN INCOME AND TFP

Abstract

This paper develops a model to assess the quantitative effects of entry costs and financial frictions on cross-country income and total factor productivity (TFP) differences, with a primary focus on the interaction between entry costs and financial frictions. The model is calibrated to match the establishment-level statistics for the U.S. economy, assuming a perfect financial market. The simulations based on the calibrated model show that entry costs and financial frictions together account for 55% and 46% of the cross-country variation in output and TFP in the data. Moreover, a substantial portion of the variation is accounted for by the interaction between entry costs and financial frictions. The main mechanism is that financial frictions amplify the effect of entry costs.