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Trade and financial development

Listed author(s):
  • Do, Quy-Toan
  • Levchenko, Andrei A.

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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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
Handle: RePEc:wbk:wbrwps:3347
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  1. Ross Levine, 1990. "Financial structure and economic development," International Finance Discussion Papers 381, Board of Governors of the Federal Reserve System (U.S.).
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  4. Raghuram G. Rajan & Luigi Zingales, 2000. "The Great Reversals: The Politics of Financial Development in the 20th Century," OECD Economics Department Working Papers 265, OECD Publishing.
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  17. repec:rus:hseeco:123720 is not listed on IDEAS
  18. Kletzer, Kenneth & Bardhan, Pranab, 1987. "Credit markets and patterns of international trade," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 57-70, October.
  19. David M. G. Newbery & Joseph E. Stiglitz, 1984. "Pareto Inferior Trade," Review of Economic Studies, Oxford University Press, vol. 51(1), pages 1-12.
  20. Beck, Thorsten & Demirguc-Kunt, Asli & Levine, Ross, 1999. "A new database on financial development and structure," Policy Research Working Paper Series 2146, The World Bank.
  21. Marco Terrones & Eswar S Prasad & Ayhan Kose, 2003. "Financial Integration and Macroeconomic Volatility," IMF Working Papers 03/50, International Monetary Fund.
  22. Bhagwati, Jagdish, 1994. "Free Trade: Old and New Challenges," Economic Journal, Royal Economic Society, vol. 104(423), pages 231-246, March.
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