Globalization and Productivity in the Developing World

We explore the productivity impact of international trade in a monopolistically competitive economy with endogenous mark-ups due to credit market frictions. We show that reducing trade barriers in such an environment (i) may - but not necessarily must – have a negative impact on productivity and output; (ii) is bound to increase the polarization of the income distribution. The reason is that the pro-competitive effects of trade reduce mark-ups and hence the borrowing capacity of less affluent entrepreneurs. As a result, smaller firms may no longer be able to make the investments required to operate the high-productivity technology. Our findings are consistent with evidence from developing countries which (i) does not suggest a clear-cut impact of trade on economic performance; (ii) hints at an inequality-increasing effect of globalization.