Capital Allocation and Wealth Distribution in a Global Economy with Financial Frictions

Abstract

This paper constructs a two-country model in which firms with heterogeneous production efficiency are subject to financial constraints. In our setting, the total factor productivity of the aggregate production function in each county depends on the cutoff level of production efficiency of firms. We first show that in the presence of international capital mobility, the cutoff condition is affected by the wealth distribution between the two countries. We then examine the existence and stability of the steady-state equilibrium of the world economy as well as the long-run impacts of real and financial shocks. It is shown that, compared to global financial shocks, global real shocks have larger impact on income and wealth in each country, especially if heterogeneity of production efficiency among firms is sufficiently low. The tractability of the model made it possible to analytically derive the main results.