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Endowment Versus Finance: A Wooden Barrel Theory of International Trade

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  • Mr. 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.

Suggested Citation

  • Mr. Jiandong Ju & Shang-Jin Wei, 2005. "Endowment Versus Finance: A Wooden Barrel Theory of International Trade," IMF Working Papers 2005/123, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2005/123
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    2. Yang Jiao & Yi Wen, 2012. "Capital, finance, and trade collapse," Working Papers 2012-003, Federal Reserve Bank of St. Louis.
    3. Kalina Manova & Zhiwei Zhang, 2008. "China's exporters and importers: firms, products, and trade partners," Working Paper Series 2008-28, Federal Reserve Bank of San Francisco.
    4. Besedeš, Tibor & Kim, Byung-Cheol & Lugovskyy, Volodymyr, 2014. "Export growth and credit constraints," European Economic Review, Elsevier, vol. 70(C), pages 350-370.
    5. Dingming Liu & Pu Chen & Chunyang Wang, 2015. "How Local Financial Market Conditions, Interest Rates, and Productivity Relate to Decisions to Export," Annals of Economics and Finance, Society for AEF, vol. 16(2), pages 315-334, November.
    6. Yongfu Huang & Jonathan Temple, 2005. "Does external trade promote financial development?," Bristol Economics Discussion Papers 05/575, School of Economics, University of Bristol, UK.
    7. Jiandong Ju & Shang-Jin Wei, 2014. "A Solution to Two Paradoxes of International Capital Flows," Economic and Political Studies, Taylor & Francis Journals, vol. 2(1), pages 3-43, January.
    8. Pol Antràs & Ricardo J. Caballero, 2009. "Trade and Capital Flows: A Financial Frictions Perspective," Journal of Political Economy, University of Chicago Press, vol. 117(4), pages 701-744, August.
    9. Marianna Belloc & Samuel Bowles, 2009. "International Trade, Factor Mobility and the Persistence of Cultural-Institutional Diversity," Working Papers in Public Economics 126, University of Rome La Sapienza, Department of Economics and Law.
    10. Rafael Cezar, 2017. "Financial Development & Commercial Advantage," Global Economy Journal (GEJ), World Scientific Publishing Co. Pte. Ltd., vol. 17(1), pages 1-10, March.
    11. Haiping Zhang, 2023. "Trade‐induced sectoral upgrading and upstream financial flows," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 56(3), pages 859-896, August.
    12. Melise Jaud & Madina Kukenova & Martin Strieborny, 2018. "Finance, Comparative Advantage, and Resource Allocation," Review of Finance, European Finance Association, vol. 22(3), pages 1011-1061.
    13. 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.
    14. Subhadip Mukherjee & Soumyatanu Mukherjee & Tapas Mishra & Udo Broll, 2019. "Export investment under uncertainty: a mean-variance decision analysis for Indian manufacturing exporters," Discussion Papers 2019-18, University of Nottingham, GEP.
    15. Qun Bao & Jiayu Yang, 2009. "Is Financial Development Another Source of Comparative Advantage? Evidence from China," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 17(2), pages 15-34, March.
    16. Lei Kang & Zhouying Song, 2020. "Input-Output Efficiency of Economic Growth: A Multielement System Perspective," Sustainability, MDPI, vol. 12(11), pages 1-24, June.
    17. Christian Keuschnigg & Evelyn Ribi, 2010. "Business Taxation, Corporate Finance and Economic Performance," University of St. Gallen Department of Economics working paper series 2010 2010-04, Department of Economics, University of St. Gallen.
    18. 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.
    19. repec:wsr:wpaper:y:2014:i:130 is not listed on IDEAS
    20. Kalina Manova, 2013. "Credit Constraints, Heterogeneous Firms, and International Trade," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 80(2), pages 711-744.
    21. Rafael Cezar, 2012. "Le développement financier et les avantages commerciaux," Working Papers DT/2012/19, DIAL (Développement, Institutions et Mondialisation).
    22. Subhadip Mukherjee & Soumyatanu Mukherjee & Tapas Mishra & Udo Broll & Mamata Parhi, 2021. "Spot exchange rate volatility, uncertain policies and export investment decision of firms: a mean-variance decision approach," The European Journal of Finance, Taylor & Francis Journals, vol. 27(8), pages 752-773, May.

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    More about this item

    Keywords

    WP; external finance; financial system;
    All these keywords.

    JEL classification:

    • F11 - International Economics - - Trade - - - Neoclassical Models of Trade
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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