July 2012 The Interaction of Entry Barriers and Financial Frictions in Growth* Jose Asturias University of Minnesota and Federal Reserve Bank of Minneapolis Sewon Hur University of Minnesota and Federal Reserve Bank of Minneapolis Timothy J. Kehoe University of Minnesota, Federal Reserve Bank of Minneapolis, and National Bureau of Economic Research Kim J. Ruhl Stern School of Business, New York University ABSTRACT_________________________________________________________________________ This paper studies the interaction between financial frictions and entry barriers on growth. We construct a model in which aggregate growth is driven by the continual entry of new firms that face barriers to entry and financial frictions. We find that reforms to financial frictions and entry barriers are substitutes—once a country has enacted one type of reform, the percentage increase in GDP from the other reform decreases. We also show that economies with more severe financial frictions and entry costs have lower levels of output along the balanced growth path, even though all economies grow at the same constant rate. The model generates sharp predictions regarding the rate of firm creation, aggregate output levels, and aggregate growth rates, which are borne out in the cross country data. __________________________________________________________________________ * The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. This paper was previously circulated with the title, "Firms, Frictions, and Barriers to Growth".