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Financial Development and Labor Markets (Fonseca & Doornik)

Financial Development and Labor Markets: evidence from Brazil by Julia Fonseca and Bernardus Van Doornik published by Banco Central do Brasil (8/2020).

“This paper investigates the importance of financial constraints for the allocation of resources across firms. The underlying hypothesis is that credit constraints cause some firms to be small relative to their optimal size, leading to lower aggregate productivity. And while a growing literature documents that capital and labor are often misallocated across producers, there is still relatively little causal evidence that financial frictions contribute to this misallocation. Moreover, even less is known about aspects of resource misallocation that extend beyond the allocation of capital and labor, such as the allocation of the skill.

To conduct this analysis, we assemble a comprehensive quarterly panel of Brazilian firms by merging matched employer-employee data with firm-level credit registry data, and with data on assets, investment, and output. In order to establish the causal effect of an increase in the borrowing capacity of firms, we exploit a bankruptcy reform that was introduced in Brazil in 2005 in order to facilitate the recovery of claims by secured creditors when a firm is liquidated. This regulation significantly strengthened the rights of secured creditors, and led to a sharp increase in the expected rate of recovery. Exploiting cross-sectional variation in measures of financial constraints, we document that the reform led to a sizable and significant increase in firms’ access to bank credit…”

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