Publication Type

Working Paper

Version

publishedVersion

Publication Date

12-2015

Abstract

We embed financial frictions and sector-specific minimum investment requirements (MIR) in a two-factor, two-sector, overlapping-generation model and showthat whether trade integration leads to convergence of the income levels among member states depends on their level of financial development. It helps reconcilethe mixed empirical evidence on trade integration and income dynamics in differentgroups of countries from the institutional perspective. In the recent decades, trade globalization has allowed developed countries to specialize towards the high-MIR, high-return production stages and tasks through international fragmentation of production and global sourcing. In our model, the “sectors” can be interpreted broadly as production stages and tasks. Free trade mayinduce the more financially developed countries to specializefully in the high-MIR,high-return “sector”, which fundamentally changes the credit market condition and the way the interest rate is determined. In this case, free trade may amplify rather than eliminate the global imbalances (a phenomenon of the large capital flows from developing to developed countries observed in the recent years), opposite to the findings of Antras and Caballero (2009, Journal of Political Economy). This way, we argue that trade and financial integration should be analyzed jointly and trade-driven structural changes may reshape our understanding of capital flows.

Keywords

financial development, financial integration, minimum investment requirements, symmetry breaking, trade integration, wealth inequality

Discipline

Finance | International Economics

Research Areas

Macroeconomics; International Economics

First Page

1

Last Page

61

Publisher

SMU Economics and Statistics Working Paper Series, No. 15-2015

City or Country

Singapore

Copyright Owner and License

Authors

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