Trade and Capital Flows A Financial Frictions Perspective.pdfVIP

Trade and Capital Flows: A Financial Frictions Perspective Pol Antra`s Harvard University, National Bureau of Economic Research, and Centre for Economic Policy Research Ricardo J. Caballero Massachusetts Institute of Technology and National Bureau of Economic Research The classical Heckscher-Ohlin-Mundell paradigm states that trade and capital mobility are substitutes in the sense that trade integration re- duces the incentives for capital to flow to capital-scarce countries. In this paper we show that in a world with heterogeneous financial de- velopment, a very different conclusion emerges. In particular, in less financially developed economies (South), trade and capital mobility are complements in the sense that trade integration increases the return to capital and thus the incentives for capital to flow to South. This interaction implies that deepening trade integration in South raises net capital inflows (or reduces net capital outflows). It also implies that, at the global level, protectionism may backfire if the goal is to rebalance capital flows. We are grateful to Davin Chor, Arnaud Costinot, Elhanan Helpman, Kalina Manova, Jim Markusen, Roberto Rigobon, Rob Shimer, Jose´ Tessada, three anonymous referees, and seminar participants at Banco Central de Chile, Boston College, Brown, Connecticut, Gerzensee, Harvard, Hong Kong University, Michigan, Massachusetts Institute of Tech- nology, London School of Economics, New York University, New York Fed, Oxford, Prince- ton, Stanford, University of California, Santa Cruz, Vanderbilt, Virginia, and the 2007 conference of the Nordic International Trade Seminars for useful comments. We thank Sergi Basco and especially Eduardo Morales for valuable research assistance and Davin Chor, C. Fritz Foley, and Kalina Manova for providing data. Caballero than