Dispersion in Financing Costs and Development

We study how dispersion in financing costs and financial contract enforcement affect entrepreneurship, firm dynamics and economic development in an economy in which financial contracts are imperfectly enforced. We use employee-employer administrative linked data combined with data on financial transactions of all formal firms in Brazil to show how interest rate spreads vary with firm size, age and loan characteristics, such as loan size and loan maturity. We present a model of economic development based on a modified version of Buera, Kaboski, and Shin (2011) which are consistent with those facts and provide evidence on the effects of financial reforms on economic development. Eliminating dispersion in financing costs leads to more credit and higher output due to cheaper credit for productive agents with low assets. Moreover, abstracting from heterogeneity in interest rate spreads understates the impacts of financial reforms that improve the enforcement of credit contracts.