Endogenous Firm Heterogeneity under Financial Imperfection: Effects of International Goods and Capital Mobility

The paper investigates the role of wealth distributions and financial institutions of an economy on within-industry firm heterogeneity in productivity. If there is no financial imperfection so that entrepreneurs are not constrained in borrowing, all of them make the same, optimal, productivity-enhancing investment. As a result, the industry will be composed of many homogeneous firms. If there exists financial imperfection, on the other hand, borrowing is constrained so the initial wealth of an entrepreneur becomes important. Given that the individuals of the economy are endowed with heterogeneous wealth, entrepreneurs with different wealth levels may choose different investment levels, resulting in the firm heterogeneity in productivity. The paper examines the impacts of the goods and capital trade between North and South, which differ only in the quality of their financial institution. We find that international capital movement will expand the differentiated good sector in North with a better financial institution and shrink the same sector in South. International trade of goods, on the other hand, amplifies this impact of capital mobility when capital is mobile across the countries; but it affects the market structures only when it is accompanied by international capital mobility. Preliminary and incomplete ∗Graduate School of Economics, Hitotsubashi University, Kunitachi, Tokyo 186-8601 Japan. Email: [email protected] †Graduate School of Economics, University of Tokyo. Email: [email protected]