Liquidity and International Trade

This paper introduces a framework to study the links between the supply of liquid assets for the financial market and the international allocation of economic activity. Private assets’ liquidity properties—their usefulness as collateral or media of exchange in financial transactions— affect assets’ values and interest rates, with consequences on firm entry, production, aggregate productivity, and total market capitalization. In a closed economy, the liquidity market increases the size and productivity of the sector of the economy that generates liquid assets. In an open economy, however, cross-country differences in financial development—as measured by the degree of liquidity of a country’s assets—generate an allocation of real economic activity that favors the country that supplies the most liquid assets. In such a setting, trade liberalization magnifies the gap in economic activity between the countries. JEL Classification: E43, E44, F12, F40