International Trade and Capital Movement under Financial Imperfection

Abstract

We construct a simple two-country model that enables us to examine the interactions between trade in goods and international capital movement under financial imperfection. We show that they are complements in the sense that trade in goods facilitates capital outflow from the South, which is either financially less-developed or endowed less capital than the North. This complementarity disappears if financial institution is perfect or almost perfect; trade in goods and capital movement are substitutes as traditional literature shows in such cases. We also show the possibility that capital
account liberalization entails capital leakage from the manufacturing industries to an inferior investment opportunity.