Does financial sector development affect the growth gains from trade openness?

Abstract

A sizeable literature suggests that financial sector development could be an important enabler of the growth benefits of trade openness. We provide a comprehensive analysis of how financial development can affect the relationship between trade openness and growth using a dynamic panel threshold model and an extensive dataset for a large sample of countries for the 1970–2015 period. We find that there is a financial development threshold in which trade openness has a positive and significant link with economic growth. We also find that when splitting the sample into industrialized and non-industrialized countries, the financial development threshold that enables the trade and growth association is higher in the former group of countries than in the latter. This finding is consistent with the fact that the export composition of industrialized countries is tilted towards more capital-intensive finance-constrained goods.