the choice of model parameters which try to match the growth rate of income. The subsistence sector is so profitable relative to setting up a business that by 1988 all entrepreneurial activity disappears and everyone in the subsistence sector earns the same amount. It is clear that focusing on the growth rate alone has perverse effects on the rest of statistics We now modify the benchmark model to mimic part of the Thai reality, allowing an exogenous increase in the intermediated sector from 6 percent to 26 percent from 1976-1996 as described in Table 2 in the Appendix. We weight each year and all the variables equally and search again for the parameters v, _w_ and **7gr,** allowing the best fit of the five variables. The parameters are M = 0.026, _w_ = 0.321 and<sup>**ygr**=</sup> 0. The corresponding graphs are presented in Figure 5, page 42.

The modified intermediated model's explanation of events differs sharply from that of the benchmark without an intermediated sector. Now the model is able to generate simulated time series which track the Thai economy more accurately. In the model, the growth rate of income is again lower than that of the Thai economy. The model still starts with negative growth until 1984. The initial phase of negative growth comes from an initial overly high aggregate wealth in the economy. But growth jumps to 5.4 percent by 1987. This high growth phase comes from the rapid expansion of credit during those years. Finally, the growth rate declines after 1987 monotonically, driven by the imposed diminishing returns in the production function. The model matches remarkably well the labor share levels and changes, especially after 1990 where they both show a steady rise. The savings rate is only closely matched<sup>for</sup> the period 1987-1996. The model also predicts a slightly decreasing fraction of entrepreneurs until 1985 and then a steady increase from 8.7 percent in 1985 to 16 1 percent in 1995, resembling more the actual levels. Finally, the Gini coefficient folows a slightly decreasing, then slightly increasing, and finally sharply decreasing trend, starting at .481 in 1976, then .377 by 1985, increasing to .451<sup>by1991and</sup> declining again to .284 by 1996. Beneath these macro aggregates lie the model's underpinnings. Growth after 1985 is driven by a steady decline out of the subsistence sector, with income from earned wages and from profits steadily increasing to 1990. Profits per entrepreneur are particularly high. Then, with the subsistence sector depleted entirely, the wage increases faster, and profits begin to decrease. Thus labor share picks up and inequality falls.

To isolate the role of credit, we can consider the same economy, at the same parameter values, but without the intermediated sector. In such a no-credit benchmark economy, roughly 80 percent of the labor force are still subsisters by 1996. In fact, this benchmark model is only capable of replicating the savings rate. It under-predicts labor share, the Gini coefficient, and the fraction of entrepreneurs. Labor share starts (low) at 7.7 percent and rises to 29.8 percent by 1988. The Gini coefficient declines<sup>from.462</sup> in 1976 to .238 by 1988. From then onwards, both simulated series remain constant until 1996. Income growth is very badly matched, starting low initially and converging from negative to zero growth rate by 1996. The negative growth comes from a relative abundance of wealth in the economy: households eat and save that wealth as they move toward the subsistence growth rate of zero. We conclude then that the credit liberalization is solely responsible for the growth experience that the intermediated model displays.

# 7.2 Simulations with Parameters from the Townsend-Thai Data

The simulation generated from the economy with no access to intermediation at the Townsend-Thai parameters, displays similar characteristics to the one using the SES data parameters and hence is not reported.

17