Finance and Competition

Financial constraints are often thought as representing a barrier to entry for new firms, thus potentially limiting competition in product markets. We investigate the relationship between finance and product market competition in the context of a general equilibrium, two-sector model. The analysis highlights the role played by firm heterogeneity as well as by the level and distribution of wealth. Financial development may lead to lower markups (and thus to more competitive markets) in financially dependent sectors, even when it reduces the number of firms and increases standard market concentration indexes. The analysis implies that incumbency is not a sufficient condition to oppose financial liberalization. It also implies that, for a given level of imperfect financial development, poorer countries will tend to have less competitive product markets.