DP5109 Endowment Versus Finance: A Wooden Barrel Theory of International Trade

Author(s):	Jiandong Ju, Shang-Jin Wei
Publication Date:	June 2005
Keyword(s):	factor endowment, financial development, HOS model, wooden barrel
JEL(s):	F11, G20
Programme Areas:	International Trade and Regional Economics, Institutions and Economic Performance
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=5109

This paper develops a theory of international trade in which financial development and factor endowment jointly determine comparative advantage. We apply the financial contract model of Holmstrom and Tirole to the Heckscher-Ohlin-Samuelson (HOS) framework. A key result is what we call the law of a wooden barrel: if the external finance constraint is binding, then augmenting capital stock would have no effect on output and returns. On the other hand, if the external finance constraint is not binding, the standard HOS predictions are resuscitated.