We study a simple model where entrepreneurs require capital for investment. They have heterogenous wealth and face lending constraints. Agents with little wealth cannot fund their projects, those with intermediate wealth can fund inefficiently sized projects. Only wealthy entrepreneurs attain the efficient firm size. We examine the effects of redistribution. These depend on the aggregate wealth of the economy; in low wealth countries, redistribution reduces credit penetration, efficiency and GDP, while the results are reversed in a wealthy economy. This effect depends on the quality of financial institutions: better institutions reduce the country wealth necessary for redistribution to have positive effects. We add labor as a factor to study the political economy effects of worker protection in bankruptcy and of improvements in credit market legislation.
JEL: G30, O15, O16.
Keywords: bankruptcy, credit market imperfections, firm size, wealth distribution