Trade-Driven Sectoral Upgrading and the Global Imbalances

Abstract

This paper analyzes how trade integration may affect international financial flows in a world with heterogeneous financial development. In the presence of financial frictions and sector-specific minimum investment requirements, the static gains from trade triggers the cross-sector investment reallocation on the extensive margin, which may allow the more financially developed country (North) to offshore low-return production activities and upgrade to high-return activities. This way, trade-driven sectoral upgrading in North becomes a mechanism through which the substantial decline in trade and communication costs and the resulting boom in supply-chain trade may contribute to the global imbalances in the recent decades.