Banks favor big firms by offering small firms different menu choices, which leads to disproportionate borrowing costs. I study big firm favorism in credit markets as a source of cross-country divergence and lower business dynamism.

First, I provide some new evidence on the nature of this relationship across low-, middle-, and high-income countries. Using a dataset from 71 countries, I summarize some key findings below.

Figure 1: Corporate Financing in Low-, Middle-, and High-income Countries

The disproportionate cost of borrowing drastically declines as we move from low-income to high-income countries.

Figure 2: Interest rate over firm size life cycle, age groups

Figure 3: Interest rate over firm age life cycle, size groups

So, in a way, getting older doesn't make firms wiser to negotiate better loan terms. These results suggests that there might be a more systematic reason for why there is a negative relationship between firm size and loan terms. However, I am not trying to understand that problem here.

Then, I integrate these stylized empirical facts into a Schumpeterian growth model with heterogeneous firm dynamics. Since the mathematical model I am using is quite detailed and complex, I only present the simulation results of the model with three key equations.

Figure 4: Simulation results, considering different values of φ

Table 1: Growth rate and change decomposition by firm size

Counterfactual policy interventions to alleviate disproportionate borrowing costs suggest a 10% to 21% increase in the economic growth rate in the US.