In this study, we examine the crucial role played by financial development in the relationship between trade and capital flows. We examine this relationship for 130 countries from 1980 to 2005 for different types of capital flows. We show that the relationship depends on the type of capital flows and the level of financial development. We observe a positive interaction between trade liberalisation and financial development for portfolio flows. In the case of FDI (Foreign Direct Investment), we observe an insignificant relationship. The FDI flows bypass the financial system as it flows into such countries because of other factors as side the level of the financial development.
Beck, T. (2003) Financial Dependence and International Trade. Review of International Economics, 11, 296-316. https://doi.org/10.1111/1467-9396.00384
Beck, T. (2002) Financial Development and International Trade Is There a Link? Journal of International Economics, 57, 107-131. https://doi.org/10.1016/S0022-1996(01)00131-3
Blonigen, B. (2005) A Review of the Empirical Literature on FDI Determinants. Atlantic Economic Journal, 33, 383-403. https://doi.org/10.1007/s11293-005-2868-9
Antras, P. and Caballero, R.J. (2009) Trade and Capital Flows: A Financial Frictions Perspective. Journal of Political Economy, 117, 701-744. https://doi.org/10.1086/605583
Aizenman, J. and Noy, I. (2009) Endogenous Financial and Trade Openness. Review of Development Economics, 13, 175-189. https://doi.org/10.1111/j.1467-9361.2008.00488.x
Matsuyama, K. (2004) Credit Market Imperfections and Patterns of International Trade and Capital Flows. Journal of European Economic Association, 3, 714-723. https://doi.org/10.1162/jeea.2005.3.2-3.714
Manova, K., Wei, S.J. and Zhang, Z. (2015) Firm Exports and Multinational Activity under Credit Constraints. Review of Economics and Statistics, 97, 574-588. https://doi.org/10.1162/REST_a_00480
Ju, J. and Wei, S-J. (2011) When Is Quality of Financial System a Source of Comparative Advantage? Journal of International Economics, 84, 178-187. https://doi.org/10.1016/j.jinteco.2011.03.004
Alfaro, L., Chanda, A., Kalemli-Ozcan, S. and Sayek, S. (2004) FDI and Economic Growth: The Role of Local Financial Markets. Journal of International Economics, 64, 89-112. https://doi.org/10.1016/S0022-1996(03)00081-3
Hsieh, C.T. and Klenow, P.J. (2007) Relative Prices and Relative Prosperity. American Economic Review, 97, 562-585. https://doi.org/10.1257/aer.97.3.562
Egger, H. and Kreickemeier, U. (2009) Firm Heterogeneity and the Labour Market Effects of Trade Liberalisation. International Economic Review, 50, 187-216. https://doi.org/10.1111/j.1468-2354.2008.00527.x
Caselli, F. (2005) Accounting for Cross-Country Income Differences. In: Aghion, P. and Durlauf, S., Eds., Handbook of Economic Growth, Volume 1, Chapter 9, Elsevier, Amsterdam, 679-741.
Caves, R.E. (1996) Multinational Enterprise and Economic Analysis. 2nd Edition, Cambridge University Press, Cambridge, New York and Melbourne.
Antras, P., Desai, M. and Foley, C.F. (2009) Multinational Firms, FDI Flows and Imperfect Capital Markets. Quarterly Journal of Economics, 124, 1171-1219. https://doi.org/10.1162/qjec.2009.124.3.1171
Tornell, A., Westermann, F. and Martinez, L. (2004) The Positive Link between Financial Liberalisation, Growth and Crises. NBER Working Papers 10293, National Bureau of Economic Research, Inc.
Aizenman, J. and Noy, I. (2006) FDI and Trade—Two-Way Linkages? The Quarterly Review of Economics and Finance, 46, 317-337. https://doi.org/10.1016/j.qref.2006.02.004
Chinn, M.D. and Ito, H. (2006) What Matters for Financial Development? Capital Controls, Institutions, and Interactions. Journal of Development Economics, 81, 163-192. https://doi.org/10.1016/j.jdeveco.2005.05.010
Klein, M.W. and Olivei, G. (2008) Capital Account Liberalisation, Financial Depth, and Economic Growth. Journal of International Money and Finance, 27, 861-875. https://doi.org/10.1016/j.jimonfin.2008.05.002
Chinn, M.D. and Ito, H. (2002) Capital Account Liberalization, Institutions and Financial Development: Cross Country Evidence. NBER Working Papers 8967, National Bureau of Economic Research, Inc.
De Gregorio, J. (1999) Financial Integration, Financial Development and Economic Growth. Estudios de Economia, 26, 137-161.
Beck, D.K., Demirguc-Kunt, A. and Levine, R. (2000) A New Database on the Structure and Development of the Financial Sector. World Bank Economic Review, 14, 597-605. https://doi.org/10.1093/wber/14.3.597
The World Bank (2018) World Development Indicators. Washington DC.
Levine, R. (1997) Financial Development and Economic Growth: Views and Agenda. Journal of Economic Literature, 35, 688-726.
Mody, A. and Murshid, A.P. (2005) Growing Up with Capital Flows. Journal of International Economics, 65, 249-266. https://doi.org/10.1016/j.jinteco.2004.02.003
Wacziarg, R. and Welch, K.H. (2008) Trade Liberalization and Growth: New Evidence. The World Bank Economic Review, 22, 187-231. https://doi.org/10.1093/wber/lhn007
Sachs, J.D., Warner, A., Aslund, A. and Fischer, S. (1995) Economic Reform and the Process of Global Integration. Brookings Papers on Economic Activity, 1, 1-118. https://doi.org/10.2307/2534573
Zingales, L. and Rajan, R.G. (2003) The Great Reversals: The Politics of Financial Development in the Twentieth Century. Journal of Financial Economics, 69, 5-50. https://doi.org/10.1016/S0304-405X(03)00125-9
Milner, C. and Williamson, J. (1991) The World Economy: A Textbook in International Economics. Harvester Wheatsheaf, Loughborough.
La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vishny, R.W. (1997) Legal Determinants of External Finance. Journal of Finance, 55, 1131-1150. https://doi.org/10.1111/j.1540-6261.1997.tb02727.x
Kose, M.A., Prasad, E., Rogoff, K.S. and Wei, S.J. (2006) Financial Globalization: A Reappraisal (No. w12484). National Bureau of Economic Research. https://doi.org/10.3386/w12484
Forbes, K.J. (2010) Why Do Foreigners Invest in the United States? Journal of International Economics, 80, 3-21. https://doi.org/10.1016/j.jinteco.2009.09.001
Manova, K. (2008) Credit Constraints, Equity Market Liberalizations and International Trade. Journal of International Economics, 76, 33-47. https://doi.org/10.1016/j.jinteco.2008.03.008
Alfaro, L., Kalemli-Ozcan, S. and Volosovych, V. (2008) Why Doesn’t Capital Flow from Rich to Poor Countries? An Empirical Investigation. The Review of Economics and Statistics, 90, 347-368. https://doi.org/10.1162/rest.90.2.347
Wooldridge, J. (2002) Econometric Analysis of Cross Section and Panel Data. MIT Press, Cambridge.
Sarno, L., Tsiakas, I. and Ulloa, B. (2016) What Drives International Portfolio Flows? Journal of International Money and Finance, 60, 53-72.