Trade liberalization and credit constraints: Why opening up may fail to promote convergence

Recent evidence suggests that despite opening up a country for
trade, the productivity gap between developed and emerging
economies often does not close. This paper examines credit
constraints as one channel held responsible for hampering
convergence. Specifically, we extend a Melitz and Ottaviano (2008)
type trade model with variable mark-ups to allow for endogenous
technology adoption. We consider a framework with two countries
that potentially differ with respect to credit market development.
Firms have the option to adopt a more efficient technology by
paying some fixed cost. A fraction of the fixed technology adoption
cost has to be financed externally: in a less developed credit
market, the costs of external finance and thus the total costs of
technology adoption are higher. A reduction in trade costs raises
demand abroad (pro technology-adoption effect) but reduces demand
at home because of import competition (anti technology-adoption
effect). We find that trade liberalization increases economic
performance, that is average productivity and technology adoption,
in both countries but that the productivity gap widens. Simulations
show that the welfare gap widens too. Opening up without sufficient
access to external funding thus fails to promote convergence.