Trade liberalization and credit constraints: Why opening up may fail to promote convergence

Peters, Katrin and Schnitzer, Monika (April 2012): Trade liberalization and credit constraints: Why opening up may fail to promote convergence. SFB/TR 15 Discussion Paper No. 380

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.

• Item Type: Paper
• Keywords: Trade liberalization, Technology adoption, Financial constraints, Convergence, Productivity gap
• Faculties: Special Research Fields > Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems; Special Research Fields > Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems > B5 - Weltwirtschaftliche Integration und die neue Firmenorganisation; Economics; Economics > Chairs > Seminar for Comparative Economics
• Subjects: 300 Social sciences > 330 Economics
• JEL Classification: F1, O33, O16
• Language: English