Financial Frictions and Gains (Losses) from Trade

47 Pages Posted: 20 Aug 2020 Last revised: 15 Nov 2021

See all articles by Mehran Ebrahimian

Mehran Ebrahimian

Stockholm School of Economics

Hamid Firooz

Department of Economics, University of Rochester

Date Written: July 29, 2020

Abstract

This paper develops a novel model of international trade with cross-country financial friction heterogeneity to analyze the effects of financial frictions on the gains from trade, and to show that these effects depend on financial development of trading partners. In the model, although product markets are competitive, production in finance-dependent sectors is supported by economic profits which prevent firms from strategic default on loans. Trade liberalization reduces the price of finance-dependent goods, which benefits consumers; However, economic profits of producing finance-dependent goods flow out of a financially less-developed economy, which is welfare-reducing for that country. In sum, gains/losses from trade are determined by the financing friction severity of a country relative to its trade partners. Moreover, we show that while the global economy benefits from each country's financial development, a country may lose from its own financial development. We support our analysis by testing key implications of the model for profits and value added using cross-country firm- and industry-level data.

Keywords: Financial Friction, International Trade, Financial Development, Finance Dependence, Profit Shifting, Gains from Trade

JEL Classification: F10, F36, G20, G28, G32

Suggested Citation

Ebrahimian, Mehran and Firooz, Hamid, Financial Frictions and Gains (Losses) from Trade (July 29, 2020). Available at SSRN: https://ssrn.com/abstract=3662834 or http://dx.doi.org/10.2139/ssrn.3662834

Mehran Ebrahimian

Stockholm School of Economics ( email )

Drottninggatan 98
Swedish House of Finance
Stockholm, Stockholm 11160
Sweden

HOME PAGE: http://www.mehranebrahimian.com/

Hamid Firooz (Contact Author)

Department of Economics, University of Rochester ( email )

Department of Economics
227 Harkness Hall
Rochester, NY 14627
United States

HOME PAGE: http://https://sites.google.com/view/hamidfirooz/home

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