| Abstract | Financial frictions resulting from the asymmetric opening condition of Chinese financial market and agents’ overreaction to the exogenous non-equity asset bubbles lead to the result that most capital fails to enter the real economy, but is stuck in the financial sector or invested in non-equity capital. And it is one reason that Chinese economic growth slows down in recent years. The expansion of bubbles showing in the real economy is regarded as capital misallocation. Therefore, there is not enough fund for entrepreneurs to invest in projects with high productivity or innovation. For lack of capital, entrepreneurs is bias in technology choices. That is to say, firms must have to product in low efficiency, which is the reason that supply and demand is unbalance in Chinese production market.
In order to explore the mechanism by which finance frictions and non-equity asset bubbles affect the economic development, we develop a model on entrepreneur’s technology choices with structured financial frictions and non-equity asset bubbles under the frame of economic growth theory. Comparing with similar studies, this paper makes the follow contributions. Firstly, it divides the development cycle of economy into three periods, including primary stage, transformation stage and advanced stage. And we analyze the impact of financial friction resulting from the asymmetric opening condition of Chinese financial market on entrepreneurs’ choices between general projects and innovation projects in those three stages, respectively. Secondly, we present non-equity asset bubbles into Matsuyama’s model. The role of equity asset bubbles is different from that of non-equity asset bubbles in the economic development. Since non-equity asset bubbles have caused the bias selections of entrepreneurs and crowded out the investment in real economy in recent years, we focus on non-equity asset bubbles in this paper. Thirdly, we verify our conclusion via simulation in MATLAB software. The parameters we using are obtained from the existing research on economic structure, firms’ productivity and innovation.
We conclude from the model: (1) Financial frictions raise the threshold for entrepreneurs’ accessing to innovation projects, thus prevent entrepreneurs from carrying on innovation projects. Namely, the greater the degree of financial frictions is, the higher the threshold of investment in innovation projects is. (2) The impact of non-equity asset bubbles directly leads to capital under-accumulation, and then restricts entrepreneurs to invest in innovation projects. (3) A decline in production efficiency caused by severe financial frictions limits entrepreneurs to invest innovation projects, which may bring about mid-income trap.
According to the simulation, we can gain that: (1) The impact of financial frictions on entrepreneurs’ technology choices are diverse with different degrees of financial friction. When the degree of financial friction is high, most entrepreneurs will manage firms with mature technology, when the degree of financial frictions is low, firms with advanced technology will be operated, when the degree of financial frictions is in the medium range, entrepreneurs will trade-off between high-index projects and low-index ones on the basis of their net worth. In a word, it will be easily for entrepreneurs achieve innovation projects with the decrease in the degree of financial frictions. (2) Entrepreneur’s capital that investing to real economy would be crowded out when there is an expansion on non-equity asset bubbles, which may lead little capital to support production and asset bubbles expansion, then the economy maybe bankrupt as well as financial crisis or economic crisis might be occur. (3) At the beginning of non-equity asset bubbles, some entrepreneurs will not keep a project and get return by trade of non-equity asset bubbles. In the long run, there exists a bubble equilibrium when the degree of financial frictions is low. There also exist a bubbleless equilibrium with a high degree of financial frictions. Hirano and Yanagawa (2010) argued that bubbles are likely emerge when the degree of financial frictions in middle range, which can explain the results we capture from simulation.
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