Working Paper: CEPR ID: DP5109
Authors: Jiandong Ju; Shangjin Wei
Abstract: This paper develops a theory of international trade in which financial development and factor endowment jointly determine comparative advantage. We apply the financial contract model of Holmstrom and Tirole to the Heckscher-Ohlin-Samuelson (HOS) framework. A key result is what we call the law of a wooden barrel: if the external finance constraint is binding, then augmenting capital stock would have no effect on output and returns. On the other hand, if the external finance constraint is not binding, the standard HOS predictions are resuscitated.
Keywords: factor endowment; financial development; HOS model; wooden barrel
JEL Codes: F11; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| binding external finance constraint (F34) | capital underutilization (E22) |
| financial development (O16) | capacity to utilize resources effectively (D24) |
| financial development (O16) | output in capital-intensive industries (D24) |
| financial development (O16) | output in labor-intensive sectors (J24) |