When is quality of financial system a source of comparative advantage?

Dominant theories of trade tend to ignore the role of finance as a source of comparative advantage. On the other hand, the finance literature places financial institutions as a driver of economic growth. This paper unites these two competing schools of thought in a general equilibrium framework. For economies with high-quality institutions (defined by the competitiveness of the financial sector, the quality of corporate governance, and the level of property rights protection), finance is passive. On the other hand, for economies with low-quality institutions, the quality of the financial system is an independent source of comparative advantage. Interestingly, the conventional measure of financial development (the size of the financial market relative to GDP) does not adequately capture the underlying quality of financial institutions. In addition, free trade may reduce the aggregate income in South. Financial capital tends to flow from South to North. (c) 2011 Published by Elsevier B.V.