Comparative advantage, demand for external finance, and financial development

Quy-Toan Do,Andrei A Levchenko

doi:10.1016/j.jfineco.2006.11.004

Quy-Toan Do, Andrei A Levchenko

Open Access

https://doi.org/10.1016/j.jfineco.2006.11.004

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Abstract

This paper analyzes the effect of comparative advantage in international trade on a country's level of financial development. Countries with comparative advantage in financially intensive goods experience a higher demand for external finance, and therefore financial development. By contrast, financial development is lower in countries that primarily export goods which do not rely on external finance. We use disaggregated trade data to develop a measure of a country's external finance need of exports, and demonstrate this effect empirically. In order to overcome the simultaneity problem, we develop a novel instrumentation strategy based on the exogenous geographic determinants of trade patterns.

Highlights

A quick glance at levels of ...nancial development across countries reveals large di¤erences
La Porta, Lopez-de-Silanes, Shleifer and Vishny (1998) provide empirical evidence that a country’s legal origin is a strong and arguably exogenous determinant of a country’s ...nancial development. When it comes to institutions more broadly, Acemoglu, Johnson and Robinson (2001) document that the quality of institutions is largely determined by settler mortality rates during the colonial period. Applying these insights to international trade immediately suggests a pattern of comparative advantage: countries endowed with better ...nancial systems will specialize in goods that rely on external ...nance in production
It is often argued that institutional quality in general and ...nancial development in particular are shaped largely by exogenous events in the past

Summary

Introduction

A quick glance at levels of ...nancial development across countries reveals large di¤erences. La Porta, Lopez-de-Silanes, Shleifer and Vishny (1998) provide empirical evidence that a country’s legal origin is a strong and arguably exogenous determinant of a country’s ...nancial development. When it comes to institutions more broadly, Acemoglu, Johnson and Robinson (2001) document that the quality of institutions is largely determined by settler mortality rates during the colonial period. Applying these insights to international trade immediately suggests a pattern of comparative advantage: countries endowed with better ...nancial systems will specialize in goods that rely on external ...nance in production. This idea has been formalized theoretically by Kletzer and Bardhan (1987), Baldwin (1989), and Ju and Wei (2005), and has found empirical support in a number of studies (e.g. Beck, 2002, 2003, Becker and Greenberg, 2003, Svaleryd and Vlachos, 2005, and Manova, 2005)

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