financial intermediation and hence contributing to the establishment of efficient
systems of international payments, can work as a trade facilitation factor11.
Overall, with respect to international trade, the prediction on the effects of financial
openness is that countries that are more financially open should experience greater
volumes of international trade; that is, financial openness should facilitate country’s
trade integration with any partner.
3. Methodology and data.
Based on the discussion in Section 2, the paper estimates two equations. One links
financial openness to the difference in per-capita income across countries; the other
links financial openness to a country’s international trade. Modelling strategy and
estimation methodology are described below.
3.1 Modelling strategy
Lets’ consider the income-gap equation first. The log of per-capita income y in
country i at time t is assumed to be a function of K variables plus the degree of
financial openness z (as suggested by the arguments reviewed in Section 2):
(1) yit = f(x1,it,x2,it,...xK,it,zit)
Denoting j as the partner country, the income gap between i and j can be written as:
(2) yjt - yit = f ((x1, jt -x1,it),(x2, jt - x2,it),...(xK, jt -xK,it),(zjt -zit))
For estimating equation (2), the regressors x1...xK on the r.h.s. need to be specified
Using a technology-augmented Cobb-Douglas specification for the production
function, a parsimonious set of regressors can be identified which includes (in logs):
the rates of labor accumulation (n), physical capital accumulation (k) and human
11 Kletzer and Bardhan (1987) provide a first formalization of the second channel. Further theoretical
advances and some supporting empirical evidence are reported by Beck (2001).