On he Role of Financial Fricions and he Saving Rae during Trade Liberalizaions Pol Anràs and Ricardo Caballero Harvard & MIT Augus 2009 Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 1 / 21
Inroducion The process of globalizaion involves he inegraion of goods and nancial markes of heerogeneous economies: one cenral dimension of heerogeneiy is nancial developmen; increasingly imporan role boh in he macro and rade lieraures. Rajan and Zingales (1998): nancial underdevelopmen a ecs di eren secors di erenly. di erences in nancial developmen can be deerminans of comparaive advanage. Our quesion: In such an environmen wih nancial fricions, how do goods and nancial markes inegraion inerac? Approach: Dynamic 2 2 general-equilibrium model wih cross-counry variaion in nancial developmen and cross-secoral variaion in nancial dependence. Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 2 / 21
Findings Earlier work: in less nancially developed economies, rade and capial mobiliy are complemens (focused on implicaions for seady-sae renal rae). Here: we sudy how nancial fricions and he saving rae shape he long-run e ecs of rade liberalizaion on income, consumpion and he disribuion of wealh in nancially underdeveloped economies. Key resul: when nancial fricions are imporan, he sandard saic gains from rade liberalizaion can be severely dilued over ime in nancially underdeveloped economies. endogenous ighening of credi consrains. Seady sae consumpion and income may well be lower han hose ha would be aained wihou rade liberalizaion. More likely: he higher is nancial developmen (provided ha i is below he average one in he world) he higher is he saving rae (for economies wih an open capial accoun). Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 3 / 21
Relaed Lieraure One-Secor, Macro Models: Gerler and Rogo (1990), Boyd and Smih (1997), Shleifer and Wolfenzon (2002), Reinhar and Rogo (2004), Kraay e al. (2005), Caballero, Farhi and Gourinchas (2006), Aoki, Benigno and Kiyoaki (2007), and Mendoza, Quadrini and Rios-Rull (2007). Financial Developmen as a Source of Comparaive Advanage: Bardhan and Klezer (1987), Rajan and Zingales (1998), Beck (2002), Masuyama (2005), Wynne (2005), Ju and Wei (2006), and Manova (2007), Anràs and Caballero (2009). Trade Liberalizaion and Credi Consrains: Chesnokova (2009). Second-bes lieraure. Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 4 / 21
Plan of he Talk 1 A Small-Open Economy wih Financial Fricions 2 Trade Liberalizaion wih a Closed Capial Accoun 3 Trade Liberalizaion wih an Open Capial Accoun 4 Discussion Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 5 / 21
A Small-Open Economy wih Financial Fricions Time evolves coninuously. In niesimal agens are born a a rae φ per uni of ime and die a he same rae; populaion mass is consan and equal o L. All agens are endowed wih one uni of labor services which hey supply inelasically o he marke. Ineremporal preferences are such ha agens save all heir income and consume only when hey die. If W denoes aggregae savings accumulaed up o dae, hen aggregae consumpion a ime is φw. The economy produces wo goods (1 and 2) and agens consuming a ime allocae heir spending beween hese wo consumpion in a way ha maximizes η 1 η C1 C2 U = (1) η 1 η Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 6 / 21
Producion Physical capial is he only sore of value in he economy and is freely radable wihin borders. iniial sock of capial is equal o K 0, ha here is no depreciaion. New physical capial can be produced by combining goods 1 and 2 according o he same uiliy aggregaor in (1). he relaive price of capial q is equal o he ideal price index, q = (p 1 ) η (p 2 ) 1 η = 1 (hence, W = K ). Producion in boh secors combines physical capial and labor according o: Y i = Z (K i ) α (L i ) 1 α, i = 1, 2. (2) Alhough echnology is idenical in boh secors, we hink of producion in secor 1 as being relaively more complex only a fracion µ of he populaion knows how o operae ha producion echnology (enrepeneurs) Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 7 / 21
Facor Markes Goods and labor markes are perfecly compeiive and facors of producion are freely mobile across secors. Key feaure: he capial marke has a fricion and his fricion has an asymmeric e ec in he wo secors. for simpliciy, nancial conracing in secor 2 is perfec (unlimied supply of capial a he equilibrium renal rae δ); when invesing in secor 1, reniers are willing o lend o enrepreneurs only an amoun proporional o he wealh of enrepreneurs (secor 1 is more complex). Hence, capial invesed by enrepreneur i is I i θk i, for θ > 1. (3) If θ is su cienly large, (3) does no bind and enrepreneurs are able o allocae a fracion η of economy s capial o secor 1 ( rs-bes). For nancial consrains o bind we need: Assumpion 1: µθ < η. Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 8 / 21
Equilibrium Under A.1, nancial consrain binds and allocaion of capial o secor 1 is given by K 1, = θs K, (4) where s K e /K is he share of wealh (and hus of he physical capial sock) in he hands of enrepreneurs. As long as nancial consrains bind in world markes, his economy faces a relaive price π p 2 /p 1 < 1. In order o characerize he dynamic pah of his economy, noe ha aggregae savings of each group (enrepreneurs e and reniers r) evolve according o: K e = φs K + µw L + s R K, (5) K r = φ (1 s ) K + (1 µ)w L + δ (1 s ) K. (6) Noaion: w wage rae; δ renal rae; R enrepreneurial reurn Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 9 / 21
Equilibrium Facor Prices Equilibrium facor prices can in urn be obained by 1 equaing he wage rae o he value of he marginal produc of labor in each secor; 2 imposing facor marke clearing 3 equaing he value of he marginal produc of capial in secor 1 and 2 o δ (θ 1) /θ + R /θ and δ, respecively. De ning ρ (s, π) (1 θs ) π 1/α + θs < 1 we obain yield: w = (1 α) Z π 1 η ρ (s, π) K α L δ = αz π 1/α+η 1 ρ (s, π) K L R = 1 + θ π 1/α 1 δ. Noe: w and δ increase in π, R decreases in π. α 1 Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 10 / 21
Dynamics and Seady Sae We can now express he dynamic pah of K and s in erms of hese wo sae variables and exogenous parameers: K = Z π 1 η (ρ (s, π) K ) α L 1 α φk α (1 s ) 1 π 1/α θs (s µ) (1 α) ρ (s, π) ṡ = Z ρ (s, π) K α 1. L Sysem is sable and converges o a unique seady sae wih associaed facor prices: Z w (ρ (s = (1 α), π)) α 1/(1 α) φ φ π 1 η δ = αφ π1/α ρ (s, π) Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 11 / 21 π 1 η
Trade Liberalizaion wih a Closed Capial Accoun Suppose now ha economy experiences an unexpeced rade liberalizaion a T > 0. We hink of his economy as being relaively nancially underdeveloped: rade will end o increase he relaive price of he economy s expor secor, which is he less nancially dependen secor 2. So π goes up. Good 1 PPF N PPF S p N p S Good 2 Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 12 / 21
E ec on Renal Rae In he dynamic version of AC, we emphasized he fac ha rade liberalizaion increases he seady-sae value of he renal rae of capial δ. This is he resul of wo forces: 1 Impac E ec: δ increases wih π holding consan s. Trade inegraion allows Souh o furher specialize in is comparaive advanage secor, which is he secor wihou nancial fricions (renier capial works wih more labor). 2 Dynamic E ec: Trade reduces he enrepreneurial reurn and hence s gradually falls hrough ime and seles a a seady sae level ha is decreasing in π. Because δ is decreasing in s his leads o furher increases in he renal rae along he ransiion pah. Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 13 / 21
More on he Dynamic E ec Remember ha his economy is ine cien because i is unable o allocae enough resources o he complex secor 1. By reducing he share of capial in he hands of enrepreneurs, rade liberalizaion aggravaes his problem and may qualify he sandard argumens in favor of rade liberalizaion. The increased misallocaion of capial across secors leads o a gradual decline in he wage rae (w is increasing in s ). incidenally, his is why δ goes up along he ransiion p 2 = ζ (δ ) α (w ) 1 α. This does no mean ha seady-sae wages are necessarily lower, since he impac e ec is posiive. Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 14 / 21
Our Firs Key Resul The gradual ighening of credi condiions also gradually reduces he growh of consumpion and income along he ransiional pah. Proposiion 1: Consider an economy wih a level of nancial developmen below he average world level (θ < θ W ). Then, here is a unique hreshold θ such ha if θ > θ, a rade liberalizaion reduces seady-sae wages, consumpion and oupu, while he converse is rue for θ < θ. Inuiion: saic gains from rade are relaively lower for economies wih θ closer o θ W ; ighening of nancial consrains is more pronounced in economies ha had less binding nancial consrains o begin wih. Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 15 / 21
An Illusraion A. Trade Liberalizaion for θ = 1.1 2.8 Pah of C, rade liberalisaion a =10 2.85 Pah of Y, rade liberalisaion a =10 0.014 Pah of K growh, rade liberalisaion a =10 2.7 2.8 0.012 2.75 2.6 2.7 0.01 2.5 2.65 0.008 2.4 2.6 2.3 2.55 0.006 2.2 2.1 No liberalisaion Wih liberalisaion 2.5 2.45 2.4 No liberalisaion Wih liberalisaion 0.004 0.002 No liberalisaion Wih liberalisaion 2 0 10 20 30 40 50 60 70 80 2.35 0 10 20 30 40 50 60 70 80 0 0 10 20 30 40 50 60 70 80 B. Trade Liberalizaion for θ = 1.4 3 Pah of C, rade liberalisaion a =10 3.1 Pah of Y, rade liberalisaion a =10 0.012 Pah of K growh, rade liberalisaion a =10 2.9 3 0.01 2.8 2.9 2.7 0.008 2.8 2.6 0.006 2.7 2.5 2.4 2.3 No liberalisaion Wih liberalisaion 2.6 2.5 No liberalisaion Wih liberalisaion 0.004 0.002 No liberalisaion Wih liberalisaion 2.2 0 10 20 30 40 50 60 70 80 90 0 10 20 30 40 50 60 70 80 90 0 0 10 20 30 40 50 60 70 80 90 Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 16 / 21
Trade Liberalizaion wih an Open Capial Accoun So far small open economy is linked o he world economy only hrough he goods marke. Consider now he case in which he counry undergoes a rade liberalizaion while having an open capial accoun. Dynamics of he domesically owned capial sock K and he share s of his capial are analogous o hose above, bu he deerminaion of facor prices is now quie di eren. The real renal rae will be pinned down by world markes (ne capial in ows or ou ows). For simpliciy, we assume ha he world renal rae is ime-invarian. Now he capial-labor raio in secor 2 is pinned down by he world renal rae and ime-invarian parameers =) wage rae is also independen of local condiions (and ime invarian): w = 1 α αz π η 1/(1 α) δ W. α δ W Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 17 / 21
Facor Prices wih an Open Capial Accoun A process of rade liberalizaion raises he wage rae, reduces he reurn o enrepreneurial capial, and leaves he renal rae of capial unchanged. Facor prices jump o heir new level on impac and remain a ha level hereafer. Furhermore, an increase in π always increases aggregae income on impac (provided π < π W ). Bu he fac ha facor prices remain consan afer he rade liberalizaion episode does no imply ha he economy does no feaure ineresing dynamics afer he shock. Impac changes on facor prices a ec aggregae income, he incenives of he economy o inves as well as he wealh accumulaion pahs of enrepreneurs and reniers. dynamics of K and s sill very much a eced, and credi consrains again become igher (s falls). Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 18 / 21
Our Second Key Resul Proposiion 2: Consider an economy wih an auarky relaive price π below he world relaive price. Then, here exis hresholds θ and φ such ha ha if θ > θ or φ < φ, a rade liberalizaion reduces seady-sae wages, consumpion and oupu. So rade liberalizaion is more likely o reduce seady-sae consumpion and oupu, he higher is he level of nancial developmen θ and he propensiy o save 1 φ. New Resul: Economies wih high saving raes (low levels of φ) end o accumulae higher levels of enrepreneurial capial income relaive o labor income, and hus he negaive e ec of rade on he share s is paricularly harmful for hose economies. Why does he saving rae maer wih an open capial accoun bu no wih a closed capial accoun? Disribuion of wealh will be much more responsive o he savings rae in economies where facor prices are pinned down by in l markes. Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 19 / 21
An Illusraion A. Trade Liberalizaion for φ = 0.1 3 Pah of C, rade liberalisaion a =10 3 Pah of Y, rade liberalisaion a =10 0.025 Pah of K growh, rade liberalisaion a =10 2.9 2.95 2.8 2.9 0.02 2.7 2.6 2.85 0.015 2.8 2.5 2.4 2.75 0.01 2.3 No liberalisaion Wih liberalisaion 2.7 No liberalisaion Wih liberalisaion 0.005 No liberalisaion Wih liberalisaion 2.2 2.65 2.1 0 10 20 30 40 50 60 70 80 2.6 0 10 20 30 40 50 60 70 80 0 0 10 20 30 40 50 60 70 80 B. Trade Liberalizaion for φ = 0.075 3.4 Pah of C, rade liberalisaion a =10 3.35 Pah of Y, rade liberalisaion a =10 0.012 Pah of K growh, rade liberalisaion a =10 3.3 3.3 3.2 3.25 0.01 3.1 3.2 0.008 3 3.15 2.9 3.1 0.006 2.8 3.05 2.7 3 0.004 2.6 No liberalisaion Wih liberalisaion 2.95 No liberalisaion Wih liberalisaion 0.002 No liberalisaion Wih liberalisaion 2.5 2.9 0 20 40 60 80 100 120 140 160 180 2.85 0 20 40 60 80 100 120 140 160 180 0 0 20 40 60 80 100 120 140 160 180 Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 20 / 21
Discussion Some limiaions of he analysis: 1 Some resuls may be sensiive o he way we have modeled nancial consrains. in our model rade opening ighens credi consrains by reducing wealh inequaliy, bu alernaive frameworks migh predic a negaive link beween wealh inequaliy and nancial fricions (see Banerjee and Du o, 2003). 2 Our resul regarding he role of he saving rae is derived from a paricularly sylized modelling of ineremporal subsiuion in consumpion, and also seems o be paricularly ied o he propensiy o save of enrepreneurs. lack of ineremporal subsiuion complicaes welfare analysis. Fuure research should shed ligh on he robusness of our resuls in richer and more realisic frameworks. Anràs and Caballero (Harvard & MIT) Financial Fricions and Trade Liberalizaion Augus 2009 21 / 21