Trade and financial development

In poorer countries trade promotes a decrease in financial systems

This paper explores the linkages between financial sector development in a country and its trade pattern. In particular the paper examines whether openness to trade affects a countries’ financial development

In order to do so, the paper builds a model in which each country's financial system is an endogenous outcome of entrepreneurs’ demand for external finance. This means that when a poor and a rich country open to trade, the poorer country begins to import the financially dependent good, rather than produce it domestically. This in turn implies that demand for external finance decreases, and the domestic financial system deteriorates.

The study provides empirical evidence that trade openness affects countries’ financial systems differentially. In richer countries trade promotes financial system growth; in poorer countries the effect is the opposite.

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Trade and financial development