Ebook Credit Constraints, Heterogeneous Firms, and International Trade

Three stylized facts describe fundamental features of international trade patterns: First, while most countries export to at least one destination in each sector, they export to only a quarter of all potential trade partners in an average sector. Second, there is significant variation in export volumes and the range of products exported across country pairs and sectors. Finally, there is substantial turnover in the product composition of exports over time. More than a quarter of all bilaterally exported products are discontinued from one year to the next and replaced by new ones, resulting in the reallocation of 16% of bilateral trade by value.

This paper provides evidence that credit constraints are an important determinant of global trade patterns and a crucial element in the explanation of all three stylized facts. I develop a multi sector model with credit constrained heterogeneous firms, countries at different levels of financial development, and sectors of varying financial vulnerability. This model delivers rich empirical predictions for export patterns which find strong support in the data.

In the model credit constraints affect firms in different countries and sectors differentially. In particular, for technological reasons, firms in some sectors need to finance a greater share of their export costs externally. In addition, sectors differ in their endowment of tangible assets that can serve as collateral. Thus, entrepreneurs find it easier to start exporting in some sectors because they need to raise less outside finance or because potential investors expect a higher return in case of default. Similarly, credit constraints vary across countries because contracts between firms and investors are more likely to be enforced at higher levels of financial development. If the financial contract is enforced, the firm makes a payment to the investor; otherwise the firm defaults and the creditor claims the collateral. Firms therefore find it easier to obtain external finance in countries with high levels of financial contractibility.

In the absence of credit constraints, all firms with productivity above a certain cut off level become exporters as in Melitz (2003). Credit constraints, however, interact with firm heterogeneity and reinforce the selection of only the most productive firms into exporting: Because more productive firms raise higher revenues, they can offer creditors a greater return in case of repayment and are hence more likely to secure the outside capital necessary for exporting. The model thus predicts that the productivity cut$off for exporting varies systematically across countries and sectors. It is higher in financially vulnerable industries which require a lot of outside finance or have few collateralizable assets, and is lower in countries with high levels of financial contractibility. Importantly, the effect of financial development is more pronounced in financially vulnerable sectors.

Embedding credit constraints in this heterogeneous firms model delivers rich empirical predictions. Countries are more likely to export to any given trade partner in a financially vulnerable sector if they are more financially developed. The model can thus account for the many instances of zero bilateral export flows, the many asymmetric cases of country pairs with positive exports in only one direction, and the systematic variation in these patterns across countries and sectors. Given positive exports, the model also predicts that in financially vulnerable sectors more firms become exporters and export greater volumes when located in more financially developed countries. It follows that financially developed countries export a wider variety of products and relatively higher volumes in financially vulnerable sectors.