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Inward versus Outward Growth Orientation in the Presence of Country Risk

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  • Aizenman, Joshua

Abstract

The purpose of this paper is to model the role of trade dependency in determining the access of a developing economy to the international credit market, and its desirable growth strategy. With full integration of capital markets the choice with respect to the inwardness of a technology is irrelevant: investment will be channeled to the more productive sectors, independently of their trade inwardness, With limited capital market integration a given investment will generate two effects. The first is the standard, direct productivity effect that is associated with the change in future output. The second is the trade dependency externality, generated by the change in future bargaining outcomes due to the change in the trade dependency of the nation. With partial integration, investment that increases trade dependency is desirable. If the credit markets are disjoint due to partial defaults, higher trade dependency is disadvantageous. Thus, higher trade dependency generates a positive externality with partial integration of capital markets, and a negative externality with disjoint credit markets. We show that credit market integration is determined by the size of the indebtedness relative to the trade dependency, as reflected by the repayment burden that is supported by the bargaining outcome. The repayment bargaining outcome is determined by the sectoral composition of the economy and by the effective size of the developing and the developed economies.

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Bibliographic Info

Article provided by London School of Economics and Political Science in its journal Economica.

Volume (Year): 58 (1991)
Issue (Month): 229 (February)
Pages: 57-77

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Handle: RePEc:bla:econom:v:58:y:1991:i:229:p:57-77

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References

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  1. Tabellini, Guido & Alesina, Alberto, 1989. "External Debt, Capital Flight and Political Risk," Scholarly Articles 4553019, Harvard University Department of Economics.
  2. Rudiger Dornbusch, 1986. "External Debt, Budget Deficits and Disequilibrium Exchange Rates," NBER Working Papers 1336, National Bureau of Economic Research, Inc.
  3. Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, vol. 18(2), pages 155-162, April.
  4. Edwards, Sebastian, 1986. "Country risk, foreign borrowing, and the social discount rate in an open developing economy," Journal of International Money and Finance, Elsevier, vol. 5(1, Supple), pages S79-S96, March.
  5. Kletzer, Kenneth M, 1984. "Asymmetries of Information and LDC Borrowing with Sovereign Risk," Economic Journal, Royal Economic Society, vol. 94(374), pages 287-307, June.
  6. Ethier, Wilfred J, 1982. "National and International Returns to Scale in the Modern Theory of International Trade," American Economic Review, American Economic Association, vol. 72(3), pages 389-405, June.
  7. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  8. Alvin E Roth, 2008. "Axiomatic Models of Bargaining," Levine's Working Paper Archive 122247000000002376, David K. Levine.
  9. Arad, Ruth W. & Hillman, Arye L., 1979. "Embargo threat, learning and departure from comparative advantage," Journal of International Economics, Elsevier, vol. 9(2), pages 265-275, May.
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Cited by:
  1. Andersson, Thomas & Burenstam Linder, Staffan, 1991. "East Asian Development and Japanese Direct Investment," Working Paper Series 312, Research Institute of Industrial Economics.

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