Financial Market Globalization and Endogenous Inequality of Nations

This paper analyzes the effects of financial market globalization on the crosscountry pattern of development in the world economy. To this end, it develops a dynamic macroeconomic model of imperfect credit markets, in which the domestic investment becomes borrowing-constrained at the lower stage of development. In the absence of the international financial market, the world economy converges to the symmetric steady state, and the cross-country difference disappears in the long run. It is shown that, under some parameter values, financial market globalization causes the instability of the symmetric steady state and generates stable asymmetric steady states, in which the world economy is polarized into the rich and the poor. The world output is smaller, the rich are richer and the poor are poorer in these asymmetric steady states than in the (unstable) symmetric steady state. The model thus demonstrates the possibility that financial market globalization may cause, or at least magnify, inequality among nations, and that the international financial market is a mechanism through which some countries become rich at the expense of others. Furthermore, the poor countries cannot jointly escape from the poverty trap by merely cutting their links to the rich. Nor would foreign aids from the rich to the poor eliminate inequality; as in a game of musical chairs, some countries must be excluded from being rich. JEL classification numbers: E44 (Financial Markets and the Macroeconomy), F43 (Economic Growth of Open Economies), O11 (Macroeconomic Analyses of Economic Development)