Trade and Financial Development

30 Pages Posted: 20 Apr 2016

See all articles by Quy-Toan Do

Quy-Toan Do

World Bank - Development Research Group (DECRG)

Andrei A. Levchenko

Massachusetts Institute of Technology (MIT)

Date Written: June 17, 2004

Abstract

The differences in financial systems between industrial and developing countries are pronounced. It has been observed, both theoretically and empirically, that the differences in countries' financial systems are a source of comparative advantage in trade.

Do and Levchenko point out that to the extent a country's financial development is endogenous, it will in turn be influenced by trade. They build a model in which a country's financial development is an equilibrium outcome of the economy's productive structure: in countries with large financially intensive sectors, financial systems are more developed. When a wealthy and a poor country open to trade, the financially dependent sectors grow in the wealthy country, and so does the financial system. By contrast, as the financially intensive sectors shrink in the poor country, demand for external finance decreases and the domestic financial system deteriorates. The authors test their model using data on financial development for a sample of 77 countries. They find that the main predictions of the model are borne out in the data: trade openness is associated with faster financial development in wealthier countries, and with slower financial development in poorer ones.

This paper - a product of the Development Research Group - is part of a larger effort in the group to investigate the relation between finance and trade.

Suggested Citation

Do, Quy Toan and Levchenko, Andrei A., Trade and Financial Development (June 17, 2004). World Bank Policy Research Working Paper No. 3347. Available at SSRN: https://ssrn.com/abstract=610391

Quy Toan Do (Contact Author)

World Bank - Development Research Group (DECRG) ( email )

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Washington, DC 20433
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Andrei A. Levchenko

Massachusetts Institute of Technology (MIT)

50 Memorial Drive
Cambridge, MA 02139-4307
United States

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