Credit, Inequality and Trade

Conventional wisdom suggests that in a credit constrained economy with uneven asset distribution underinvestment and income inequality is a general possibility as poor agents are barred from accessing loans from banks. This has implications for skill formation, entrepreneurship, trade and poverty. General assertion is that more even asset distribution is desirable to promote investment and efficiency. Contrary to the conventional wisdom, this paper argues that more egalitarian asset distribution is likely to reduce output of the credit intensive sector when credit limit is determined by the level of asset ownership, firms face binding credit constraints for all levels of asset holding and firms are price takers. Therefore, it is not the inequality of asset distribution but imperfect product market that adversely affects the efficiency outcome. Trade does not worsen inequality within groups of entrepreneurs and non-entrepreneurs, but inequality increases across groups. However, the country with more egalitarian distribution of assets, in contrast to usual outcome, may import credit intensive good and export capital to the rest of the world.