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Endowment Versus Finance

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Author Info

  • Jiandong Ju
  • Shang-Jin Wei

Abstract

This paper develops a theory of international trade in which financial development and factor endowments jointly determine comparative advantage. We apply the financial contract model of Holmstrom and Tirole (1998) to the Heckscher-Ohlin-Samuelson (HOS) model in which firms'' dependence on external finance is endogenous, and the demand for external finance is constrained by financial development. The theory nests HOS model as a special case. A key result that emerges is what we call the law of a wooden barrel: if the external finance constraint is binding, then further financial development will increase the output of the industry more dependent on external finance, and decrease the output of the other industry. It is shown that financial development makes both labor and unemployed capital better off, but incumbent capital worse off. Therefore, financial development depends on the relative strength of political forces among labor, unemployed capital owners, and incumbent capital owners. If only the capital constraint is binding, on the other hand, the standard HOS predictions will apply.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/123.

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Length: 29
Date of creation: 01 Jun 2005
Date of revision:
Handle: RePEc:imf:imfwpa:05/123

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Related research

Keywords: Economic models; Financial sector; external finance; external capital; international trade; capital market; capital owners; political economy; factor endowments; moral hazard; capital ratio; stock market; stock market capitalization; free trade; domestic credit; credit market; capital movement; trade pattern; commodity trade; factor price; factor markets; pattern of trade; capital structure; investor protection; capital markets; capital inflows; capital expenditures; economic outcomes; capital endowments; trade data; international capital; free trade in goods; protection of investors; capital flows; trade structure; elasticity of substitution; capital revenue; standard trade theory; capital stock; capital market imperfections; per capita income; capital intensive industry; interest groups; unit of capital; external funding; trade theory; export shares; return on capital; trade model; patterns of trade;

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References

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  1. Hart, O. & Moore, J., 1989. "Default And Renegotiation: A Dynamic Model Of Debt," Working papers 520, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. John Romalis, 2004. "Factor Proportions and the Structure of Commodity Trade," American Economic Review, American Economic Association, vol. 94(1), pages 67-97, March.
  3. Ronald W. Jones, 1965. "The Structure of Simple General Equilibrium Models," Journal of Political Economy, University of Chicago Press, vol. 73, pages 557.
  4. RAFAEL LaPORTA & FLORENCIO LOPEZ-de-SILANES & ANDREI SHLEIFER & ROBERT W. VISHNY, . "Legal Determinants of External Finance,"," CRSP working papers 324, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  5. Donald R. Davis & David E. Weinstein, 1998. "An Account of Global Factor Trade," Harvard Institute of Economic Research Working Papers 1849, Harvard - Institute of Economic Research.
  6. Kenneth Kletzer and Pranab Bardhan., 1986. "Credit Markets and Patterns of International Trade," Economics Working Papers 8612, University of California at Berkeley.
  7. Diamond, Douglas W, 1991. "Debt Maturity Structure and Liquidity Risk," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 709-37, August.
  8. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
  9. Raymond Fisman & Inessa Love, 2004. "Financial Development and Growth in the Short and Long Run," NBER Working Papers 10236, National Bureau of Economic Research, Inc.
  10. Trefler, Daniel, 1993. "International Factor Price Differences: Leontief Was Right!," Journal of Political Economy, University of Chicago Press, vol. 101(6), pages 961-87, December.
  11. Berglof, Erik & von Thadden, Ernst-Ludwig, 1994. "Short-Term versus Long-Term Interests: Capital Structure with Multiple Investors," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 1055-84, November.
  12. Andrei A. Levchenko, 2004. "Institutional Quality and International Trade," IMF Working Papers 04/231, International Monetary Fund.
  13. Gene M. Grossman & Elhanan Helpman, 2002. "Integration Versus Outsourcing In Industry Equilibrium," The Quarterly Journal of Economics, MIT Press, vol. 117(1), pages 85-120, February.
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Citations

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Cited by:
  1. Jaud Melise , & Kukenova Madina & Strieborny Martin, 2010. "Finance, Comparative Advantage, and Resource Allocation," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 10.16, Université de Lausanne, Faculté des HEC, DEEP.
  2. Marianna Belloc & Samuel Bowles, 2009. "International Trade, Factor Mobility and the Persistence of Cultural-Institutional Diversity," UMASS Amherst Economics Working Papers 2009-08, University of Massachusetts Amherst, Department of Economics.
  3. Huang, Yongfu & Temple, Jonathan, 2005. "Does External Trade Promote Financial Development?," CEPR Discussion Papers 5150, C.E.P.R. Discussion Papers.
  4. Ju, Jiandong & Wei, Shang-Jin, 2011. "When is quality of financial system a source of comparative advantage?," Journal of International Economics, Elsevier, vol. 84(2), pages 178-187, July.
  5. Do, Quy-Toan & Levchenko, Andrei A., 2006. "Comparative advantage, demand for external finance, and financial development," Policy Research Working Paper Series 3889, The World Bank.
  6. Jiandong Ju & Shang-Jin Wei, 2006. "A Solution to Two Paradoxes of International Capital Flows," NBER Working Papers 12668, National Bureau of Economic Research, Inc.
  7. Rafael Cezar, 2012. "Le développement financier et les avantages commerciaux," Working Papers DT/2012/19, DIAL (Développement, Institutions et Mondialisation).
  8. Iacovone, Leonardo & Zavacka, Veronika, 2009. "Banking crises and exports : lessons from the past," Policy Research Working Paper Series 5016, The World Bank.

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