The purpose of this paper is to argue that financial development, measured by private credit in the economy, affects exports in an inverted U-shaped manner. The authors use the new trade theory model and empirical data to analyze whether the financial system is the reason of global imbalance.
This paper builds a simple production model to connect financial development with a country’s export or outward foreign direct investment (ODI) decision. Using a panel data covering 108 countries for the period 1990-2011, the authors find strong evidence to show that when a country is at a lower financial development level, further advancements of its financial system will boost exports.
First, an inverted U-shaped relationship between exports, imports and financial development is found in the study of 108 countries over the period 1990-2011; second, ODI provides a substitute effect to exports for financially advanced countries. These findings have provided an alternative explanation to international trade imbalances and contribute constructively to the discussion regarding whether exports and financial development are positively related or not.
As a result, the findings shed some light on the issue of global current account imbalances between developing and developed countries from a new perspective.
