Productivity Dynamics under Financial Integration: An Intangible-Investment Channel

Abstract

This paper proposes a novel channel, i.e., within-firm intangible-tangible investment composition, through which financial capital flows may have non-trivial implications to allocative efficiency and productivity. Consider a model where only the tangibles can be pledged as collateral for loans. Heterogeneous pledgeability gives rise to the unit-cost differential between tangible and intangible investments, which distorts within-firm allocative efficiency. By lowering the interest rate and stimulating the domestic capital formation, the inflows of cheap foreign funds change the collateral value of tangibles and the unit-cost differential, which triggers within-firm investment reallocation. It turns out that allocative efficiency and the productivity of capital formation fall in the short run, while they rise over time. The more elastic the domestic investment, the larger the financial inflows, the more likely the productivity eventually exceeds its initial level. Thus, market frictions and regulatory requirements that hamper entrepreneurial entry may reduce the elasticity of domestic investment, which undermines the productivity gains from financial inflows.