Financial constraints, the distribution of wealth and international trade

Extract: As the Heckscher-Ohlin-Mundell paradigm predicts, in a world where capital markets are perfect and production exhibits constant-returns to scale, while aggregate wealth endowments can be an important source of comparative advantage, their internal distribution does not matter for the patterns of international trade. This is because in the absence of financial frictions the only factor that determines the availability of external finance is a project's net present value. In real life financial markets are far from perfect. Informational asymmetries between lenders and borrowers, corporate governance quality shortcomings and non-negligible intermediation costs are only a sample of the types of problems that beset financial markets. The presence of financial frictions implies that the level of wealth of entrepreneurs is a second factor that lenders need to consider when providing external finance. Now some entrepreneurs with profitable projects but insufficient wealth cannot obtain external funds; i.e. they are financially constrained. A steadily growing literature examines the implications of financial constraints for the patterns and volume of international trade. Not surprisingly, cross-country differences in the quality of financial institutions and wealth distributions matter. These issues become more prominent at times of global financial market upheaval where financial constraints are universally tighter.