Trade and Capital Flows: A Financial Frictions Perspective

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 HeckscherOhlin model, trade liberalization always decreases the wage-rental in South: an anti-StolperSamuelson result. JEL Codes: E2, F1, F2, F3, F4. Keywords: Trade, capital mobility, capital ‡ows, globalization, …nancial frictions, complementarities, factor payments, saving rate, global imbalances, protectionism. Harvard and NBER, and MIT and NBER, respectively. We are grateful to Arnaud Costinot, Davin Chor, Elhanan Helpman, Kalina Manova, Jim Markusen, Roberto Rigobon, Jose Tessada and seminar participants at Banco Central de Chile, Boston College, Brown, Connecticut, Gerzensee, Harvard, Michigan, MIT, LSE, NYU-New York Fed, Princeton, Stanford, Vanderbilt, Virginia and the 2007 NOITS conference for useful comments. We thank Sergi Basco and especially Eduardo Morales for valuable research assistance. Caballero thanks the NSF for …nancial support. First draft: May 11, 2007.