We set up a dynamic stochastic model of a stylized economy comprising a final output sector (with traditional and modern firms) and an intermediate goods sector. It is shown that market integration reduces the volatility of the rate of return to capital invested in modern firms. The induced portfolio decisions of households lead to a reallocation of capital from traditional to modern firms. Despite the presence of a reverse precautionary saving channel, the growth rate unambiguously increases because of the reallocation of capital. Empirical estimates for OECD countries support the theoretical results.
