Globalization under Financial Imperfection

The paper investigates the effects of international trade in goods and capital movement on the productivity distribution and industry-wide productivity when countries are heterogeneous in the quality of their financial institutions. In autarky, firm heterogeneity in their productivities arises in countries with poor financial institutions, while all firms adopt a high-productivity technology in countries with better financial institutions. Trade in goods will not change the productivity distribution and hence the industry-wide productivity in any country, although it lowers equilibrium interest rates in countries with poor financial institutions while it raises them in countries with better financial institutions. Allowing international capital movement in addition to the trade, however, makes a large impact on the industry. Capital flight from countries with poor financial institutions occurs, leading to either (i) all firms in the world adopt the high-productivity technology under a relatively high interest rate, or (ii) some firms adopt the high-producitivity technology while others adopt the low-productivity technology in every country in the world under a low interest rate. The latter occurs more likely if many countries with poor financial institutions carry out the capital account liberalization, reducing the world-wide efficiency of the industry. Very preliminary and incomplete ∗This manuscript is prepared for the UNSW International Trade Workshop and Hitotsubashi COE Conference on International Trade and FDI. †Graduate School of Economics, Hitotsubashi University, Kunitachi, Tokyo 186-8601 Japan. Email: [email protected] ‡Graduate School of Economics, University of Tokyo. Email: [email protected]