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.