Trade and Capital Flows: A Financial Frictions Perspective

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Abstract:

The classical Heckscher-Ohlin-Mundell paradigm states that trade and capital mobility are substitutes, in the sense that trade integration reduces the incentives for capital to ‡ow to capital-scarce countries. In this paper we show that in a world with heterogeneous …nancial development, the classic conclusion does not hold. In particular, in less …nancially developed economies (South), trade and capital mobility are complements. Within a dynamic framework, the complementarity carries over to (…nancial) capital ‡ows. This interaction implies that deepening trade integration in South raises net capital in‡ows (or reduces net capital out‡ows). It also implies that, at the global level, protectionism may back…re if the goal is to rebalance capital ‡ows, when these are already heading from South to North. Our perspective also has implications for the e¤ects of trade integration on factor prices. In contrast to the Heckscher- Ohlin model, trade liberalization always decreases the wage-rental in South: an anti-Stolper- Samuelson result.

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