Trade-Driven Sectoral Upgrading and the Global Imbalances

This paper analyzes theoretically how trade integration affects financial capital flows in a world with heterogeneous financial development. In the presence of financial frictions and sector-specific minimum investment requirements, the static gains from trade trigger the cross-sector investment reallocation along the extensive margin, which may allow the more financially developed country (North) to gradually offshore low-return production activities and eventually upgrade fully in high-return activities. Then, trade-induced production upgrading in North may lead to the international interest rate reversal and re-reversal sequentially, which has non-trivial implications on the direction of financial capital flows. This finding complements that of Antras and Caballero (2009)