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Trade Liberalization and the Politics of Financial Development

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  • Braun, Matias

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 political equilibrium level of financial system development. This may be perturbed by the effect of trade liberalization in 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 induces 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 is difficult to obtain more blatant forms of anti-competitive measures from politicians.

Suggested Citation

  • Braun, Matias, 2004. "Trade Liberalization and the Politics of Financial Development," Santa Cruz Department of Economics, Working Paper Series qt70v7f9ff, Department of Economics, UC Santa Cruz.
  • Handle: RePEc:cdl:ucscec:qt70v7f9ff
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    Cited by:

    1. Augusto De La Torre & Sergio L. Schmukler, 2004. "Whither Latin American Capital Markets?," World Bank Publications, The World Bank, number 25933, July.
    2. repec:idb:idbbks:349 is not listed on IDEAS
    3. Marco Pagano & Paolo Volpin, 2005. "Shareholder Protection, Stock Market Development, and Politics," CSEF Working Papers 149, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    4. Becker, Bo, 2006. "City Size and Financial Development," SIFR Research Report Series 46, Institute for Financial Research.
    5. Efraim Benmelech & Tobias J. Moskowitz, 2010. "The Political Economy of Financial Regulation: Evidence from U.S. State Usury Laws in the 19th Century," Journal of Finance, American Finance Association, vol. 65(3), pages 1029-1073, June.
    6. Feal-Zubimendi, Soledad, 2009. "Financial Development and Trade Openness: a Survey," MPRA Paper 63341, University Library of Munich, Germany.
    7. 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, September.
    8. 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.
    9. Manova, Kalina, 2008. "Credit constraints, equity market liberalizations and international trade," Journal of International Economics, Elsevier, vol. 76(1), pages 33-47, September.

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