Firm Heterogeneity, International Trade and Credit Market Imperfection

We build up a simple Ricardian trade model with imperfection in the market for credit which affects the pattern of production. Workers/entrepreneurs are endowed with different levels “capital†and need to borrow to produce the credit intensive good. We argue that in such a framework identical countries may gain from trade without the assumption of comparative advantage. Such a trade will be based on fragmentation. Firms with strong internal cash flow will enter the credit intensive sector. Among those the weaker ones will like to deal in fragments and the richer ones will vertically integrate. Later we generalize our framework where prices and interest rate are determined simultaneously. We also argue why fragmentation may lead to greater efficiency in the presence of credit constraints.