CAPITAL-MARKET IMPERFECTIONS, INTERNATIONAL CREDIT MARKETS, AND NONCONVERGENCE

We consider a two country growth model with international capital mark ets. These markets fund capital investment in both countries, and oper ate subject to a costly state verification (CSV) problem. Investors in each country require some external finance, but also provide internal finance, which mitigates the CSV problem. When two identical (except for their initial capital stocks) economies are closed, they necessari ly converge monotonically to the same steady state output level. Unres tricted international financial trade precludes otherwise identical ec onomies from converging, and poor countries are necessarily net lender s to rich countries. Oscillation in real activity and international ca pital flows can occur. (C) 1997 Academic Press.