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Trade and financial development

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  • Do, Quy-Toan
  • Levchenko, Andrei A.

Abstract

The differences in financial development between advanced and developing countries are pronounced. It has been observed, both theoretically and empirically, that these differences in countries'financial systems are a source of comparative advantage and trade. This paper points out that to the extent a country's financial development is endogenous, it will in turn be influenced by trade. The paper builds a model in which a country's financial development is an equilibrium outcome of the economy's productive structure: in countries with large financially intensive sectors financial systems are more developed. When a wealthy and a poor country open to trade, the financially dependent sectors grow in the wealthy country, and so does the financial system. By contrast, as the financially intensive sectors shrink in the poor country, demand for external finance decreases and the domestic financial system deteriorates. This paper describes the authors'test model using data on financial development for a sample of 77 countries. The authors find that the main predictions of the model are borne out in the data: trade openness is associatedwith faster financial development in wealthier countries, and with slower financial development in poorer ones.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 3347.

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Date of creation: 01 Jun 2004
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Handle: RePEc:wbk:wbrwps:3347

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Keywords: Payment Systems&Infrastructure; Economic Theory&Research; Environmental Economics&Policies; Fiscal&Monetary Policy; Labor Policies; Economic Theory&Research; Environmental Economics&Policies; TF054105-DONOR FUNDED OPERATION ADMINISTRATION FEE INCOME AND EXPENSE ACCOUNT; Macroeconomic Management; Inequality;

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References

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  1. Kenneth Kletzer and Pranab Bardhan., 1986. "Credit Markets and Patterns of International Trade," Economics Working Papers 8612, University of California at Berkeley.
  2. David H. Romer & Jeffrey A. Frankel, 1999. "Does Trade Cause Growth?," American Economic Review, American Economic Association, vol. 89(3), pages 379-399, June.
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  4. Rajan, Raghuram G & Zingales, Luigi, 1998. "Financial Dependence and Growth," American Economic Review, American Economic Association, vol. 88(3), pages 559-86, June.
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  9. Acemoglu, Daron & Zilibotti, Fabrizio, 1998. "Information Accumulation in Development," Seminar Papers 652, Stockholm University, Institute for International Economic Studies.
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  11. Dani Rodrik, 1998. "Why Do More Open Economies Have Bigger Governments?," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 997-1032, October.
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  18. repec:rus:hseeco:123720 is not listed on IDEAS
  19. Beck, T.H.L. & Demirgüç-Kunt, A. & Levine, R., 2000. "A new database on financial development and structure," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3125518, Tilburg University.
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