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Trade liberalization and the politics of financial development

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  • Matías Braun
  • Claudio Raddatz

Abstract

A well-developed financial system enhances competition in the industrial sector by allowing easier entry. The impact varies across industries, however. For some, small changes in financial development quickly induce entry and dissipate incumbents’ rents, generating strong incentives to oppose improvement of the financial system. In other sectors incumbents may even benefit from increased availability of external funds. The relative strength of promoters and opponents determines the equilibrium level of financial system. This may be perturbed by the effect of trade liberalization on the strength of each group. Using a sample of 41 trade liberalizers, we conduct an event study and show that the change in the strength of promoters vis-à-vis opponents is a very good predictor of subsequent financial development. The result is not driven by changes in demand for external funds or by the success of the trade policy. The relationship is mediated by policy reforms, the kind that induce competition in the financial sector, in particular. Real effects follow not so much from capital deepening but mainly through improved allocation. The effect is stronger in countries with high levels of governance, suggesting that incumbents resort to this costly but more subtle way of restricting entry where it is difficult to obtain more blatant forms of anti-competitive measures from politicians.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Boston in its series Working Papers with number 04-3.

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Date of creation: 2004
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Handle: RePEc:fip:fedbwp:04-3

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Keywords: International trade ; Financial modernization;

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Citations

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Cited by:
  1. Julian di Giovanni & Andrei A. Levchenko, 2006. "Openness, Volatility and the Risk Content of Exports," 2006 Meeting Papers 86, Society for Economic Dynamics.
  2. Pagano, Marco & Volpin, Paolo, 2005. "Shareholder Protection, Stock Market Development and Politics," CEPR Discussion Papers 5378, C.E.P.R. Discussion Papers.
  3. Do, Quy-Toan & Levchenko, Andrei A., 2007. "Comparative advantage, demand for external finance, and financial development," Journal of Financial Economics, Elsevier, vol. 86(3), pages 796-834, December.
  4. Eduardo Siandra, 2005. "Uruguay Capital Market: Law-in-the-books or Law-in-action?," Documentos de Trabajo (working papers) 0205, Department of Economics - dECON.
  5. Enrico Perotti & Paolo Volpin, 2007. "Investor Protection and Entry," Tinbergen Institute Discussion Papers 07-006/2, Tinbergen Institute.
  6. Efraim Benmelech & Tobias J. Moskowitz, 2007. "The Political Economy of Financial Regulation: Evidence from U.S. State Usury Laws in the 19th Century," NBER Working Papers 12851, National Bureau of Economic Research, Inc.
  7. Becker, Bo, 2006. "City Size and Financial Development," SIFR Research Report Series 46, Institute for Financial Research.
  8. Kalina Manova, 2008. "Credit Constraints, Heterogeneous Firms, and International Trade," NBER Working Papers 14531, National Bureau of Economic Research, Inc.
  9. Kim, Dong-Hyeon & Lin, Shu-Chin & Suen, Yu-Bo, 2010. "Dynamic effects of trade openness on financial development," Economic Modelling, Elsevier, vol. 27(1), pages 254-261, January.
  10. Augusto de la Torre & Sergio L. Schmukler, 2007. "Emerging Capital Markets and Globalization : The Latin American Experience," World Bank Publications, The World Bank, number 7187, August.
  11. Alexander Aganin & Paolo Volpin, 2005. "The History of Corporate Ownership in Italy," NBER Chapters, in: A History of Corporate Governance around the World: Family Business Groups to Professional Managers, pages 325-366 National Bureau of Economic Research, Inc.
  12. Feijen, Erik, 2005. "Do incumbents manipulate access to finance during banking crises?," Policy Research Working Paper Series 3660, The World Bank.
  13. Manova, Kalina, 2008. "Credit constraints, equity market liberalizations and international trade," Journal of International Economics, Elsevier, vol. 76(1), pages 33-47, September.
  14. Stijn Claessens & Erik Feijen, 2006. "Financial Sector Development and the Millennium Development Goals," World Bank Publications, The World Bank, number 7145, August.

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