Trade Liberalization and Credit Constraints: Why Opening Up May Fail to Promote Convergence

39 Pages Posted: 25 May 2012

See all articles by Katrin Peters

Katrin Peters

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics

Monika Schnitzer

University of Munich - Department of Economics; Centre for Economic Policy Research (CEPR)

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Date Written: April 2012

Abstract

Recent evidence suggests that despite opening up a country for trade, the productivity gap between developed and emerging economies often does not close. This paper examines credit constraints as one channel held responsible for hampering convergence. Specifically, we extend a Melitz and Ottaviano (2008) type trade model with variable mark-ups to allow for endogenous technology adoption. We consider a framework with two countries that potentially differ with respect to credit market development. Firms have the option to adopt a more efficient technology by paying some fixed cost. A fraction of the fixed technology adoption cost has to be financed externally: in a less developed credit market, the costs of external finance and thus the total costs of technology adoption are higher. A reduction in trade costs raises demand abroad (pro technology-adoption effect) but reduces demand at home because of import competition (anti technology-adoption effect). We find that trade liberalization increases economic performance, that is average productivity and technology adoption, in both countries but that the productivity gap widens. Simulations show that the welfare gap widens too. Opening up without sufficient access to external funding thus fails to promote convergence.

Keywords: Convergence, Financial constraints, Productivity gap, Technology adoption, Trade liberalization

JEL Classification: F1, O16, O33

Suggested Citation

Peters, Katrin and Schnitzer, Monika, Trade Liberalization and Credit Constraints: Why Opening Up May Fail to Promote Convergence (April 2012). CEPR Discussion Paper No. DP8942. Available at SSRN: https://ssrn.com/abstract=2066315

Katrin Peters (Contact Author)

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics ( email )

Ludwigstrasse 28
Munich, D-80539
Germany

Monika Schnitzer

University of Munich - Department of Economics ( email )

Ludwigstrasse 28
Munich, D-80539
Germany
+49 89 2180 2217 (Phone)
+49 89 2180 2767 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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