Comparative advantage, demand for external finance, and financial development

By Quy-Toan Do, Andrei A. Levchenko. 2006

287 citations recorded by the source corpus.

The differences in the levels of financial development between industrial and developing countries are large and persistent. Theoretical and empirical literature has argued that these differences are the source of comparative advantage and could therefore shape trade patterns. This paper points out the reverse link: financial development is influenced by comparative advantage. The authors illustrate this idea using a model in which a country's financial development is an equilibrium outcome of the economy's productive structure: financial systems are more developed in countries with large financially intensive sectors. After trade opening demand for external finance, and therefore financial development, are higher in a country that specializes in financially intensive goods. By contrast, financial development is lower in countries that primarily export goods which do not rely on external finance. The authors demonstrate this effect empirically using data on financial development and export patterns in a panel of 96 countries over the period 1970-99. Using trade data, they construct a summary measure of a country's external finance need of exports and relate it to the level of financial development. In order to overcome the simultaneity problem, they adopt a strategy in the spirit of Frankel and Romer (1999). The authors exploit sector-level bilateral trade data to construct, for each country and time period, a predicted value of external finance need of exports based on the estimated effect of geography variables on trade volumes across sectors. Their results indicate that financial development is an equilibrium outcome that depends strongly on a country's trade pattern.

Subfields: Economics and Econometrics, Strategy and Management

View Paper: https://www.semanticscholar.org/paper/cd210b679e0ad513cbfdd0b4490095ded164ae30

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Citations in the corpus

Credit constraints, equity market liberalizations and international trade (2008, background): “Keywords: International trade Credit constraints Equity market liberalization JEL classification: F10 F14 F36 G20 G28 G32”
When is Quality of Financial System a Source of Comparative Advantage (2011, unknown): “The labor constraint ( 17 ) and the capital constraint (18) jointly determine”
International Trade and Institutional Change (2013, unknown): “Examining the definition of IIX, (12), it is clear that this variable will have high values either because predicted overall trade X̂ic is high across all sectors – “natural openness” –, or because the country is predicted to export relatively more in the institutionally intensive sectors.”
Openness and income: The roles of trade and migration (2014, result): “…γ̂M but rather to use the predictors (6) and (7) as instruments for the trade and migration shares.10 We also note that our strategy here is in the same spirit as Do and Levchenko (2007) and di Giovanni and Levchenko (2009) who estimate a set of similar bilateral trade models at the sector level.”