Capital Constraints, Trade and Crowding Out of Southern Firms

Abstract

Introducing capital market imperfections to a 'footloose capital'’model, I show how such distortions may explain the observed phenomena of an industrialized north and an underdeveloped south. Further, I show that with inter-generational savings internationalization will cause a crowding out of manufacturing firms in the south, increasing the share of the southern population that are credit-constrained, and also reducing total income in the country. This should not, however, be taken as an argument for protectionism, as welfare may indeed be higher with trade than in autarky, if trade costs are sufficiently low.Capital constraints; Home market effect; Gain from trade