Macroeconomic Dynamics with Limited Commitment in Financial and Labor Contracts

WThis paper presents a dynamic general equilibrium model to investigate the coevolution of employment and financial systems in the process of economic development when firms f commitment to financial and labor contracts is limited. We show that equilibrium modes of financial and labor contracts endogenously change from the informal contracting phase in which both of them are implicitly self-enforced to the formal contracting phase in which they are formally enforced and become more market-based as economies develop well. Furthermore, the formal contracting phase is irreversible in the sense that, once the economy enters that regime, it never returns back to the informal contracting phase.