Comparative Advantage, Demand for External Finance, and Financial Development

42 Pages Posted: 24 Apr 2006

See all articles by Quy-Toan Do

Quy-Toan Do

World Bank - Development Research Group (DECRG)

Andrei A. Levchenko

University of Michigan - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: April 1, 2006

Abstract

The differences in the levels of financial development between advanced and developing countries are large and persistent. Theoretical and empirical literature has argued that these differences are the source of comparative advantage and could therefore shape trade patterns. This paper points out the reverse link: financial development is influenced by comparative advantage. We illustrate this idea using a model in which a country's financial development is an equilibrium outcome of the economy's productive structure: financial systems are more developed in countries with large financially intensive sectors. After trade opening demand for external finance, and therefore financial development, are higher in a country that specializes in financially intensive goods. By contrast, financial development is lower in countries that primarily export goods which don't rely on external finance. We demonstrate this effect empirically using data on financial development and export patterns in a panel of 96 countries over the period 1970-99. Using trade data, we construct a summary measure of a country's external finance need of exports, and relate it to the level of financial development. In order to overcome the simultaneity problem, we adopt a strategy in the spirit of Frankel and Romer (1999). We exploit sector-level bilateral trade data to construct, for each country and time period, a predicted value of external finance need of exports based on the estimated effect of geography variables on trade volumes across sectors. Our results indicate that financial development is an equilibrium outcome that depends strongly on a country's trade pattern.

Keywords: trade patterns, demand for external finance, financial development, gravity model

JEL Classification: F02, F14, O16, O19

Suggested Citation

Do, Quy Toan and Levchenko, Andrei A., Comparative Advantage, Demand for External Finance, and Financial Development (April 1, 2006). World Bank Policy Research Working Paper No. 3889. Available at SSRN: https://ssrn.com/abstract=898170 or http://dx.doi.org/10.2139/ssrn.898170

Quy Toan Do

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

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

Andrei A. Levchenko (Contact Author)

University of Michigan - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States

HOME PAGE: http://alevchenko.com

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
102
Abstract Views
847
rank
150,611
PlumX Metrics