Openness and financial-sector reform

There is substantial empirical evidence of a positive relationship between trade and economic growth, at least in the long run. Yet, economic success does not seem to require perfect free trade: on the one hand, most of the countries that have recently gone through “growth miracles” (e.g., South Korea and Taiwan) applied some kind of protectionism; on the other hand, a number of countries which moved quickly and comprehensively towards free trade were confronted with disappointing subsequent growth performances and rising levels of inequality. Based on these experiences, there is an emerging consensus that, when liberalizing trade, less-developed countries should follow a step-by-step approach that takes into account specific local conditions and involves an assessment of complementary reforms required to make further liberalization steps more likely to raise the incomes of a broad cross-section of society. Recent research has highlighted financial market institutions as a key area of such complementary reforms. Earlier work by Foellmi and Oechslin, for instance, shows that trade liberalization is bound to significantly amplify income inequality if there are substantial financial market frictions. This project extends the Foellmi–Oechslin framework to study the impact of trade liberalization on total-factor productivity (TFP) in developing economies. The idea is to gain a better understanding of the nature of complementary credit market reforms that are required to avoid a decline in TFP in the aftermath of significant liberalization steps.