FINANCIAL FRICTIONS AND NEW EXPORTER DYNAMICS

• Author: David Kohn,Michal Szkup,Fernando Leibovici
• Published date: 01 May 2016
• Date: 01 May 2016
• DOI: http://doi.org/10.1111/iere.12164

INTERNATIONAL ECONOMIC REVIEW

Vol. 57, No. 2, May 2016

FINANCIAL FRICTIONS AND NEW EXPORTER DYNAMICS∗

BYDAVID KOHN,FERNANDO LEIBOVICI,AND MICHAL SZKUP1

Universidad Torcuato Di Tella, Argentina; York University, Canada; University of British

Columbia, Canada

This article studies the role of financial frictions as a barrier to international trade. We study new exporter dynamics

to identify how these frictions affect export decisions. We introduce a borrowing constraint and working capital

requirements into a standard model of international trade, with exports more working capital intensive than domestic

sales. Our model can quantitatively account for new exporter dynamics in contrast to a model with sunk export entry

costs. We provide additional evidence in support of our mechanism. We find that financial frictions reduce the impact

of trade liberalization, suggesting that they constitute an important trade barrier.

1. INTRODUCTION

Although tariffs have decreased sharply across developed and emerging economies over re-

cent decades, leading to a huge expansion of international trade, large barriers to international

trade remain. Even though nontariff barriers to international trade are often hard to observe di-

rectly in the data, we argue that the dynamics of new exporters are informative of the underlying

frictions affecting firms’ export decisions.

For instance, exports and export intensity are typically increasing in the length of export

spells, whereas the probability that firms stop exporting is decreasing in the number of years

that firms have exported. Models of international trade with sunk export entry costs cannot

account for these facts (Ruhl and Willis, 2014), despite their success in accounting for key

cross-sectional facts on exporters and their entry and exit rates (Alessandria and Choi, 2014).

This suggests that firms’ exports are determined by frictions of a different kind.

In this article, we investigate the extent to which frictions in financial markets distort firms’

export decisions, acting as a barrier to international trade. We do so by studying the implications

of these frictions for new exporter dynamics. This approach is motivated by recent studies that

document a strong empirical relationship between measures of access to external finance and

international trade. Moreover, we are also influenced by the finding that financial frictions can

account for salient features of the dynamics of small firms, suggesting that such frictions may

also play a key role in driving the dynamics of new exporters, which are typically small.2

Using Chilean plant-level data, we document salient features of new exporters’ dynamics

and their use of external finance. On the one hand, we find that new exporters in Chile exhibit

the same dynamics documented for other countries by previous studies. On the other hand,

we observe that external finance plays a key role in financing working-capital expenditures.

∗Manuscript received April 2013; revised November 2015.

1We thank George Alessandria, David Backus, Gian Luca Clementi, Jonathan Eaton, Mark Gertler, Virgiliu Midri-

gan, Kim Ruhl, Mike Waugh, Daniel Xu, and seminar participants at Midwest International Trade Meeting 2011,

Midwest Macroeconomics Meeting 2011, New York University, Society for Economic Dynamics Meeting 2011, and

Pennsylvania State University for helpful comments. We would also like to thank two anonymous referees and the

editor (Harold Cole) for insightful comments that substantially improved the article. Fernando Leibovici gratefully

acknowledges the financial assistance provided by the Social Sciences and Humanities Research Council of Canada

(SSHRC) and the C.V. Starr Center for Applied Economics at New York University. Please address correspondence

to: Fernando Leibovici, York University, 1034 Vari Hall, 4700 Keele St., Toronto, ON, M3J 1P3, Canada. E-mail: ei@

yorku.ca.

2See, for instance, Arellano et al. (2012), Clementi and Hopenhayn (2006), and Cooley and Quadrini (2001).

453

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(2016) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social

and Economic Research Association

454 KOHN,LEIBOVICI,AND SZKUP

Moreover, exporters face relatively higher working-capital needs than nonexporters. These

findings guide our modeling choices.

We study an economy with heterogeneous firms and idiosyncratic productivity shocks, where

firms choose whether to trade internationally. If they choose to export, firms have to pay fixed

and variable trade costs. Note that we assume that firms’ decisions are subject to financial

constraints and working-capital requirements. In order to produce, firms pay a fraction of their

wage bill before revenues are realized, which can be financed using internal or external funds.

Although firms are free to finance these working-capital needs using internal funds, they are

required to post collateral in order to obtain external funds. We further assume that working-

capital requirements are asymmetric: The share of the wage bill that needs to be paid in advance

is higher for foreign sales.3

In our model, financial frictions distort export decisions along both the extensive and intensive

margins. On the intensive margin, financial frictions force firms with low internal funds, relative

to their productivity level, to produce below their optimal scale, thus limiting their output and

lowering their total profits. This effect also distorts the extensive margin by reducing the returns

from exporting: If a firm chooses to export, it can earn only a fraction of the profits it would

earn by operating at its optimal scale. As a result, with financial frictions, productive firms with

relatively low assets choose not to export.

We contrast our model with financial frictions to a standard model of export dynamics, in

which firms are subject to sunk export entry costs but face no frictions in financial markets.4We

separately calibrate both models to match salient features of Chilean plant-level data.

We find that the financial frictions model can account for the dynamics of new exporters

observed in the data. In our economy, the majority of new exporters enter the foreign market

financially constrained. As they accumulate internal funds, new exporters become less financially

constrained and increase their scale rapidly. This raises the return to exporting, making firms

less likely to exit the foreign market. Moreover, asymmetric working-capital requirements

imply an increase in export intensity. As the borrowing constraint is relaxed, exports increase

more than domestic sales because foreign sales are relatively more working capital intensive.

In contrast, we find that the sunk cost model cannot account for these facts: As firms begin to

export, their export exit rate increases, exports decline, and export intensity remains constant.

These findings are robust to alternative specifications of the sunk model5and suggest that it is

frictions in financial markets, instead of sunk export entry costs, which drive the dynamics of

new exporters.

Our model with financial frictions generates hysteresis in export status without sunk costs: A

firm that exported in the previous period is more likely to export in the following period since it

is likely to have higher assets than one that did not previously export. Therefore, like standard

models with sunk costs, our model can also account for export entry and exit rates.

We provide additional evidence in support of our mechanism by studying the performance

of our model along other dimensions related to marginal exporters that are not targeted in the

calibration strategy. Specifically, we look at the dynamics of domestic sales and external finance

upon entry to the export market. We also examine the rate at which firms that recently stopped

exporting reenter the foreign market. We find that our model can account for these additional

facts.

Finally, we show that the effects of trade liberalization depend crucially on whether export

entry and exit decisions are assumed to be driven by financing constraints or sunk costs. In

particular, we find that the effects of lowering trade barriers on total sales and exports are

substantially lower in the model with financial frictions than in the sunk cost model. In the

3See Section 2 for empirical evidence on asymmetric working-capital needs. For alternative finance-related mech-

anisms that may lead exporters to face higher working-capital needs, see Ahn (2011), Amiti and Weinstein (2011),

Antras and Foley (2011), and Feenstra et al. (2014).

4Das et al. (2007) and Alessandria and Choi (2014) find sunk costs to be large and important in accounting for firms’

export entry and exit rates, as well as for key cross-sectional facts of firms engaged in international trade.

5See Section 1 in the online Appendix.

FINANCIAL FRICTIONS AND NEW EXPORTER DYNAMICS 455

financial frictions model, firms with low levels of assets are unable to achieve a scale large

enough to take advantage of the lower tariffs. As a result, these firms choose not to export,

and the share of exporters increases by less than in the sunk cost model. We also find that

there are large effects from financial development, as relaxing the borrowing constraint leads

to a significant increase in exports. These findings suggest that identifying the nature of the

underlying trade barriers is important for determining the effects of trade liberalization and

financial development.

The remainder of the article is organized as follows: In the rest of this section, we review

the related literature. Section 2 presents empirical evidence on the dynamics of new exporters

and a set of salient facts on the use of external finance and working-capital needs. Section 3

presents the model. Section 4 discusses how the model works as well as the mechanism through

which the model can account for new exporter dynamics. Section 5 presents the quantita-

tive analysis of the model. Section 6 studies the policy implications of our findings. Section 7

concludes.

1.1. Literature Review. Our work is motivated by recent studies showing that trade mod-

els with sunk export entry costs cannot account for the dynamics of new exporters, despite

their success along other dimensions. Eaton et al. (2008) and Ruhl and Willis (2014) first docu-

mented the different dynamics featured by new and established exporters. In addition, the latter

showed that standard models of international trade with sunk costs cannot account for these

dynamics.

We are also motivated by studies that document a strong empirical relationship between

external finance and international trade. Using Italian data, Minetti and Zhu (2011) show that

“credit-rationed” firms are less likely to export and, to the extent that they do so, are likely to

export less. In a similar spirit, Bellone et al. (2010) document a negative relationship between

firms’ “financial health” and both their export status and export intensity.6

Our article is also related to a growing theoretical and quantitative literature that studies the

role of financial frictions in trade. Early papers that study the effects of financial constraints on

export decisions are Chaney (2013) and Manova (2013), which introduce financial constraints

into a standard static Melitz (2003) model. In parallel work, Gross and Verani (2013) also study

the role of financial frictions in accounting for new exporter dynamics. In contrast to their

work, we calibrate and examine the quantitative implications of our model using plant-level

data.

Recent quantitative studies by Caggese and Cunat (2013), Brooks and Dovis (2011), and

Leibovici (2014) have used a trade model to examine the aggregate implications of financial

frictions for international trade. The former two focus on the impact of financial frictions on

the gains from trade liberalization, whereas the latter studies the industry- and aggregate-level

implications of financial development on international trade.

Alternative explanations have been proposed to account for some of these dynamics. Eaton

et al. (2014) point to the role of search frictions to explain the small and increasing export

volumes upon entry to foreign markets. They argue that the low but increasing probability

of continuing to export arises from initial uncertainty about the idiosyncratic profitability of

exporting. Arkolakis (2011) investigates the role of marketing costs and customer capital in

explaining increasing export volumes. We present evidence in support of our mechanism and

view these alternative explanations as complementary to ours.

6See Manova (2008) and Manova (2013) for evidence on the role of financial frictions and credit market development

in explaining the observed sectoral and cross-country patterns of trade. Other papers that document the importance

of financial frictions to firms’ export decisions are Egger and Kesina (2013), Berman and Hericourt (2010), and Muuls

(2008). In contrast, Greenaway et al. (2007) find little evidence on the relevance of financial factors to firms’ exporting

decision.