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«Fernando Leibovici1 New York University JOB MARKET PAPER January 13, 2013 [Download latest version] ABSTRACT ...»

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Financial Development and International Trade

Fernando Leibovici1

New York University


January 13, 2013

[Download latest version]


————————————————————————————————————This paper studies the extent to which frictions in financial markets affect aggregate trade flows. I

study a model of firm dynamics with financial frictions and international trade, calibrated to match key features of firm-level data. I find that, while financial frictions have a large effect on the pattern and extent of international trade at the industry-level, as documented in the literature, they have a small effect on trade at the aggregate-level. Relaxing the financial constraints allows more firms to finance the upfront export entry costs, with a significant impact on industry-level trade flows to the extent that the industry is small enough to affect equilibrium prices. In contrast, removing the financial constraints at the aggregate-level leads to an increase in the wage and interest rate, thereby reducing the returns to becoming an exporter, with a small impact on aggregate trade flows. I also find that the cross-industry response of international trade to financial development is quantitatively consistent with industry-level evidence on the extent of trade across countries, and that the effectiveness of policies aimed at increasing trade by easing the access to credit for exporters is limited if implemented at an economy-wide scale.

——————————————————————————————————————————– Email: fernando.leibovici@nyu.edu. Website: http://files.nyu.edu/fml234/public/. Mailing address: 19 West 4th St, 6th floor, NYC, 10012 NY. I would like to thank Virgiliu Midrigan, Mike Waugh, Gian Luca Clementi, Jonathan Eaton, David Backus, Kim Ruhl, Ana Maria Santacreu, David Kohn, Michal Szkup, Gaston Navarro, H˚ akon Tretvoll, and Andres Zambrano for their helpful feedback and suggestions.

1 Introduction International trade costs are large, particularly in developing countries2. While recent studies have estimated large gains from reducing these costs in poor countries3, an important challenge is to identify the policies that may allow poor countries to reduce them. A recent literature has suggested that financial constraints play a key role in distorting aggregate trade flows in financially underdeveloped countries4, acting as a potentially important cost to international trade.

A salient feature of the data is that countries with less developed financial markets export a relatively smaller fraction of their GDP. A key channel through which financial frictions affect international trade flows at the industry level is by distorting firms’ export entry decisions5. In this paper, I use firm-level data to quantitatively study the extent to which financial frictions distort firms’ export entry decisions and lower international trade flows at the aggregate level in a general equilibrium framework.

I study a model of firm dynamics with international trade, financial frictions, and upfront export entry costs, and calibrate it to match key features of firm-level data. I find that differences in the magnitude of financial frictions cannot account for the relationship between financial development and international trade observed in the data at the aggregate level, even though they do predict a strong industry-level relationship as documented in the literature. While relaxing the financial constraint leads more firms to afford the costs required to start exporting, factor prices increase in equilibrium, reducing the returns to becoming an exporter. A higher level of financial development allows all constrained firms to expand, not just exporters — this increases the demand for labor and debt, driving up the wage and interest rate, and lowering the return to exporting. In contrast, removing financial constraints for an individual industry has a significant impact on that industry’s trade share to the extent to which the industry is too small to affect equilibrium prices.

The model consists of an economy populated by heterogeneous firms subject to financial constraints and international trade costs. Firms are born with an idiosyncratic level of productivity and a low initial level of capital. Financial frictions take the form of a collateral constraint, with the amount of credit available to firms limited by the value of capital that can serve as collateral at the time that Anderson and van Wincoop (2004).

Waugh (2010) shows that there can be large gains for poor countries from reducing their international trade costs to the level of richer countries.

Manova (forthcoming), Beck (2002).

Manova (forthcoming).

loans are repaid6. Moreover, firms can trade internationally, but need to pay a sunk export entry cost a period before they can start to export, as well as an ad-valorem trade cost per unit that is sold abroad7.

Financial frictions distort the firms’ decision to start exporting through two channels. First, firms with a sufficiently low capital stock cannot generate sufficient internal funds to pay for the sunk export entry cost, and don’t have enough collateral to finance it externally. Second, firms that can afford to start exporting may still operate at a sub-optimal scale upon entry to the export market if their capital stock is sufficiently low, reducing the returns to exporting. In addition, at low levels of capital, firms face a high opportunity cost to paying the export entry cost, since they could use those resources to increase their production scale. Thus, financial frictions increase the costs and reduce the returns to exporting for firms with low capital, leading them to choose not to export.

I calibrate the model to match key features of firm-level data from the Chilean Manufacturing Survey for the period 1995-2007. The model is calibrated to match firm-level moments informative about the differences between exporters and non-exporters, as well as features of the firms’ life-cycle dynamics that are informative of their financial constraint. The model is also calibrated to match the level of credit and trade at the aggregate level. I find that the model can also account for features of the data not targeted in the calibration strategy, which are key to the mechanism that I study. In particular, I find that the model can account for moments that are informative of distortions to firms’ export decisions along both the extensive and intensive margins.

I then use the calibrated model as a laboratory to study the extent to which financial frictions distort firms’ export entry decisions and lower international trade flows at the aggregate level. To do so, I compare simulated data from the calibrated model to that from a model without financial frictions. I find that financial development does not lead to an economically significant increase in the share of GDP that is exported at the aggregate level.

Even though relaxing the financial constraint would allow more firms to trade internationally, the equilibrium wage and interest rate increase thereby reducing the returns to becoming an exporter.

Thus, trade does not increase relative to total production as financial constraints are relaxed. To show For related closed-economy models of heterogeneous firms subject to financial constraints, see Midrigan and Xu (2012), Buera, Kaboski, and Shin (2011), and Buera and Moll (2012).

International trade is modeled following Melitz (2003) and Chaney (2008), and the dynamic features of Alessandria and Choi (2012).

this, I contrast these results with those obtained by keeping the equilibrium wage and interest rate fixed at their pre-financial-development level. I interpret these results as reflecting the effect of removing financial constraints in a small industry. I find that, in this case, the relative level of international trade does increase considerably. Therefore, general equilibrium effects offset a key mechanism through which financial development can lead countries to trade relatively more.

While recent studies have interpreted the strong cross-sectoral relationship between financial development and international trade as evidence of a link between them at the aggregate level, my findings suggest otherwise. For instance, Manova (forthcoming) documents that sectors with higher “external finance dependence”8 feature relatively higher international trade flows in countries that are more financially developed. She finds that the relationship observed in the data can be largely accounted by distortions to firms’ export entry and sales decisions due to financial frictions. Furthermore, she interprets her findings to suggest that financial development may have played a key role in accounting for the growth of aggregate exports across countries over recent decades.

In contrast, my findings suggest that firm- or sectoral-level evidence on the relationship between finance and international trade need not imply a link between them at the aggregate level. To evaluate this conjecture, I extend the model to feature two sectors heterogeneous in the collateralizability of the capital stock. I use this extension of the model to study the quantitative potential of financial underdevelopment to account for the cross-sectoral relationship between finance and international trade documented in the literature. I find that, even though financial development leads to a small increase in the relative level of international trade at the aggregate level, it can lead to much larger changes at the sectoral level. Thus, these findings show that, while financial underdevelopment may lower the relative level of trade at the sectoral level, it need not affect it at the aggregate level.

Similarly, a recent empirical literature has documented that financial factors are important in accounting for firms’ export entry decisions, suggesting that financial frictions may distort aggregate trade flows9. Using Italian data, Minetti and Zhu (2011) show that “credit rationed” firms are less likely to export and, to the extent that they do, they are likely to export less. In a similar spirit, Bellone, Musso, Nesta, and Schiavo (2010) report a negative relationship between firms’ “financial Sectors with high external finance dependence are interpreted to require a relatively more intensive use of external finance. For details, see Rajan and Zingales (1998).

For quantitative studies of the role of financial frictions in accounting for firms’ export decisions, see Kohn, Leibovici, and Szkup (2012) and Gross and Verani (2012).

health” and both their export status and export intensity. Suwantaradon (2012) uses data from the World Bank Enterprise Survey to show that firms with higher net worth are more likely to export.

My findings suggest that this evidence need not have implications for the share of aggregate output that is exported. In my model, while financial factors play a key role in accounting for the decisions of firms, these do not affect the relative level of trade at the aggregate level.

The remainder of the paper is organized as follows. Section 2 presents the model. Section 3 discusses how the model works, and the mechanism through which financial frictions distort aggregate trade flows and output. Section 4 presents the quantitative analysis of the model. Section 5 examines the cross-sectoral implications of the model. Section 6 concludes.

–  –  –

I now present the model that I use to study the relationship between financial development and international trade. The model consists of an economy populated by unit measures of entrepreneurs and final good producers who trade with the rest of the world. Entrepreneurs operate a firm that produces a differentiated intermediate good and supply a unit of labor inelastically. Final good producers produce final goods using domestic and imported intermediates, which entrepreneurs use for consumption and investment. The rest of the world demands goods from entrepreneurs, and supplies imported intermediate goods to final good producers.

2.1 Final good producer Final good producers purchase domestic and imported intermediate goods, and aggregate them to produce a final good. To do so, they operate a constant elasticity of substitution (CES) technology, with elasticity of substitution σ 1. Given prices {pD (i)}i∈[0,1] and pM charged by domestic entrepreneurs and the rest of the world, they choose the bundle of inputs of domestic and imported intermediates {yD (i)}i∈[0,1] and yM that maximizes their profits. Then, the final good producer’s problem can be

–  –  –

where p and y are the price and quantity of the final good, respectively.

Given prices {pD (i)}i∈[0,1], and pM, the quantity of each intermediate good demanded by final good

producers is given by the following demand functions:

–  –  –

where these are the demand functions faced by domestic entrepreneurs and the rest of the world.

2.2 Entrepreneurs Preferences Entrepreneurs are risk averse, with preferences over streams of consumption of final goods represented by the lifetime discounted sum of a constant relative risk aversion (CRRA) period

utility function:

–  –  –

where γ denotes the risk aversion parameter, β is the subjective discount factor, and 1 − ν is the probability of survival (described in more detail later in this section).

Technology Entrepreneurs produce a differentiated intermediate good by operating a constant returns to scale production technology y = zk α n1−α, where z denotes their idiosyncratic productivity level, k is the capital stock, and n is the amount of labor hired. I assume that idiosyncratic productivity z is distributed log-normal with mean µz and standard deviation σz, and is fixed over their lifetime.

Labor is hired on a period-by-period basis from competitive labor markets, while capital is accumulated internally by investing in final goods. Investment x takes a period to be transformed into capital, and capital depreciates at rate δ.

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