Understanding International Differences in Trade and Capital Market Integration
International integration in capital markets raises the cost of capital in technology-backward countries, pushing them toward specialization in labor-intensive industries. To avoid specialization and to sustain production of capital-intensive industries, governments either impose tari.s or limit the degree of capital market integration. The idea that trade and capital market distortions are substitutes is apparently contradicted by the empirical evidence, that shows that countries with more open trade regimes are also more integrated to world capital markets. However, after controlling for international productivity and factor endowment di.erences, I find a negative association between trade and capital market integration, as predicted by the model.
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