Financing Scale and Relative Prices

We study the cross-country relationship between the relative price of tradables and income per capita. The theory developed is based on financial frictions and differences in the efficient scale of production across sectors. Countries with more severe financial frictions are more dependent on self-financing, and so produce at less than efficient scale. Since tradables tend to have larger efficient scales, financial frictions and smaller scale of productions disproportionately lower productivity in tradables. We evaluate the theory using cross-country data on relative prices and financial intermediation, as well as microdata on establishment sizes in the U.S. and Mexico.