Distinguishing Constraints on Financial Inclusion and Their Impact on GDP, TFP and Inequality

Abstract

The authors developed a micro-founded general equilibrium model with heterogeneous agents and 3 dimensions of financial inclusion: access (determined by a participation cost), depth (determined by a borrowing constraint), and intermediation efficiency (determined by a monitoring cost). The authors find that the economic implications of financial inclusion policies vary with the source of frictions. In partial equilibrium, the authors show analytically that relaxing each of these constraints separately increases GDP. However, when constraints are relaxed jointly, the impacts on the intensive margin (increasing output per entrepreneur with access to credit) are amplified, while the impacts on the extensive margin (promoting credit access) are dampened. In general equilibrium, the authors discipline the model with firm-level data from 6 countries and quantitatively evaluate the policy impacts. Multiple frictions are necessary to match the country-specific variables, e.g., credit access ratio, interest rate spread, and non-performing loans. A TFP decomposition finds that most of the productivity gains are captured by a between-regime shifting effect, whereby talented entrepreneurs obtain credit and expand their businesses. In terms of inequality and welfare, reducing the participation cost benefits talented-but-poor agents the most, while relaxing the borrowing constraint or intermediation cost is more beneficial for talented-and-wealthy agents. This research was funded under the Private Enterprise Development in Low-Income Countries(PEDL) Programme