Stock markets in emerging economies often suffer from severe illiquidity. Exploiting a Chilean tax regulation, we identify a large negative causal effect of designated market maker (DMM) adoption on bid–ask spreads. A novel intraday spread distribution analysis shows the improvement is roughly split between the DMM’s binding spread obligation and liquidity externalities. These externalities arise from scale economies in liquidity provision: in thin markets, high average costs of liquidity supply force wide spreads, suppressing demand and risking market breakdown. By committing to tighter spreads, a DMM reverses this spiral by stimulating volume, diluting fixed costs, easing inventory management, and enabling further spread compression.