Finance, trade, man and machines : a new-Ricardian Heckscher-Ohlin-Samuelson model

This paper attempts to build up a Heckscher-Ohlin-Samuelson model of production and trade where capital is introduced outside the production process as a financial capital or credit as per the classical Ricardian wage fund framework. Stock of credit or financial capital as past savings, finances employment and machines or capital goods used in the process of production with Ricardian fixed coefficient technology. Availability of finance does not affect production or pattern of trade only nominal factor prices. International financial flows will not alter pattern of trade, but movement of labour and machines will. Such results change drastically when we consider a model with unemployment and finance dictates real outcomes much more than before. Introducing finance affects trade patterns with unemployment and especially with imperfect credit markets. In a two-period extension with credit demand being allocated for financing R&D expenditure, a rise in interest rate in the subsequent period will motivate perpetual tendencies to invest in machine via R&D so that machine-intensive sector will expand at the expense of the labour-intensive sector. This can account for the secular decline in labour income share as has been observed for some time. Our results are consistent with contemporary empirical evidence and have serious policy implications for role of financial development and quality of institutions for innovation and economic development. Numerical illustration corroborates this.