Trade-Driven Sectoral Upgrading and the Global Imbalances

 Haiping Zhang, the University of Auckland

The recent wave of globalization has two distinct features. First, emerging Asian economies, especially China, have witnessed large current account surplus, while advanced economies, notably the United States, have incurred persistent current account deficits in the past two decades, a phenomenon commonly known as the global imbalances. Second, the declining costs of transportation, communication, and coordination have facilitated the expansion of global production networks and supply-chain trade between advanced and emerging economies.

This paper analyses how trade integration may affect international financial 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 on the extensive margin, which may allow the more financially developed country (North) to sequentially offshore low-return production activities and upgrade to high-return activities. This way, trade-driven sectoral upgrading in North becomes a mechanism through which the rise in North-South supply-chain trade may contribute to the global imbalances in the recent decades.

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