Book Description

This dissertation studies the dynamic effect of trade liberalization on trade, especially during a transition period of trade liberalization. This research is new to the literature which has focused on the static and permanent effect of trade liberalization so far. The first and the second chapters examine the dynamics of how trade responds to trade liberalization before its actual implementation. The third chapter emphasizes the changes in several aspects of trade due to trade liberalization after its implementation. The first chapter finds that exporters enter into an export market prior to the actual implementation of a trade liberalization episode (the “early entry decision”) only if the financial market of an origin country is sufficiently developed. An empirical study of free trade agreements shows that the amount of early entry into export markets, measured as the extensive margin of trade during periods before the tariff is reduced, is positively correlated with the measure of the financial development of exporting countries. This new stylized fact can reconcile apparently contradictory findings in the existing literature about the effect of trade liberalization over time. I demonstrate that this discrepancy disappears when a measure of financial development, the relative size of private credit by banks and other financial intermediaries to GDP, is included in the regression and interacted with FTA time dummy variables.Based on this empirical finding, the second chapter provides the theoretical background of how the early entry decision of potential exporters during trade liberalization episode depends on an origin country’s financial market condition. Two essential ingredients are incorporated in a typical dynamic international trade model, which are a financial market friction as a type of borrowing constraints in the credit market and a congestion externality in the export entry resource market. The model describes how the financial market friction deters potential exporters’ entry decision even if they have incentives to enter earlier than the actual implementation of trade liberalization because of the congestion externality. The simulation result with a reasonable calibration mimics the empirical evidence of earlier entry of a financially developed exporting country. The third chapter discovers three empirical regularities: (1) As an exporting country's either labor market friction measure or financial market friction measure increases, the size of real exports after trade liberalization implementation increases more gradually when other conditions are controlled; (2) Financial market friction is more likely to deter the entry of firms into exporting markets in the transition episode (extensive margin), while labor market friction is more likely to affect the size of exports (intensive margin); (3) The impact of financial market development on exports tends to be realized earlier than the labor market frictions effect on exports. These findings shed light on the importance of both market frictions in analyzing international trade dynamics, in contrast to the existing literature that focuses on either financial market or labor market conditions.