Ebook Credit Constraints and Zero Trade Flows : The Role of Financial Development
The literature on international trade has recently concentrated on the decomposition of the intensive and extensive margins, in order to explain the evolution of the world trade. According to Helpman, Melitz and Rubinstein (2005), the increase in the world trade since 1970 has been largely driven by an extension in the volume of trade between trading partners, i.e. the intensive margin, rather than from the development of new bilateral trade relationships, i.e. the extensive margin. At the same time, there subsists a large number of bilateral trade relationships that are still not exploited.
New trade models with heterogenous firms tell us that a country will export a good to a potential partner, if the most productive domestic firm has reached the cutoff productivity level, which ensures it makes a positive profit. These models imply that a higher fixed entry cost requires that the firm has a higher productivity level. Therefore, no export occurs if no firm is productive enough to do so. Beyond the productivity issue, limitations in the access to credit are likely to influence firm’s entry decision. Chaney (2005) develops a monopolistic competition model with liquidity constrained firms, and shows that these constraints are likely to prevent firms’ entry, even if they would otherwise be productive enough to do so. However, this model does not motivates the source of liquidity constraints, which are randomly distributed across firms.
The literature on finance has investigated the sources of credit constraints that firms have to face, and the influence of financial development on growth and trade. Country-specific credit constraints depend on: (i) the degree of financial depth and the capacity of financial intermediaries to channel credit to the private sector, and (ii) the institutional environment i.e. creditor rights, contract enforcement and accounting standards. According to Levine et al. (2000), financial development enables a better allocation of capital and a reduction in information asymmetries, and thus leads to a reduction in the cost of external capital. The authors also show that cross-country differences in the legal and accounting systems help account for differences in levels of financial development. Firm-specific characteristics also generate credit constraints. Rajan and Zingales (1998) define the external financial dependence as the proportion of expenditures that are not financed with cash flow from operations, and argue that a higher level of external dependence leads to larger credit constraints. The mechanism developed in Rajan and Zingales (1998) is very simple: the borrowing cost being especially high in countries characterized by a very low level of financial development, firms using a higher proportion of external finance for their operations should also bear a higher borrowing cost in those countries. The proportion of firm’s intangible assets in the total of assets is also seen as an element that can lead to larger credit constraints. Braun (2002) relies on the theory of contracts and argues that, in a world where contracts are incomplete and where property rights are poorly enforced, the existence of hard assets is critical for the establishment of a financial relationship. More precisely, firms with a lower proportion of tangible assets will face a higher borrowing cost, especially in countries with a low development of the local financial market, since they are considered as more risky or less reliable. Finally, firm’s size is also seen as a characteristic that can lead to tighter credit constraints. According to Beck et al. (2005), SMEs face tighter credit constraints than larger firms, because of larger informational barriers. Beck et al. (2004) argue that larger firms internalize many of the allocation functions carried out by the financial markets; they are also more likely to tax the financial resources of a country if capital is very scarce. Petersen and Rajan (2002) find that distance between small firms and lenders is increasing, as a result of the increased productivity in the financial intermediary sector. This last result emphasizes the fact that distance between small firms and lenders is especially important, as a result of asymmetry of information concerns.
According to the definition of credit constraints above, financial development should promote production and trade in financial dependent industries by reducing the cost of external capital; it should also favor firms with a lower asset tangibility or a smaller size, since it is positively correlated to the quality of legal and accounting standards. Looking specifically at the finance trade relationship, Beck (2002, 2003) shows that an increase in the level of financial development has a positive impact on the value of exports, especially if industries report a higher level of external financial dependence. In a related work, Manova (2005) shows that financial development has a more positive influence on the value of exports in industries where firms are characterized by a lower share of tangible assets.
These papers only consider positive trade flows to evaluate the impact of an increase in a country’s level of financial development. However, the influence of financial development on the number of bilateral trade relationships may differ from that on the strict extension in the volume of exports by industry. Most capital accounts have been liberalized at the beginning of the nineties, and emerging economies have experienced a large increase in their level of financial development during this period. According to Rajan and Zingales (2003), countries were more financially developed in 1913 than in 1980; in the meanwhile, access to capital dramatically decreased at the time of the Great Depression and World War II. The recovery begins in the 1980’s; indeed, Rajan and Zingales (2003) note that France’s capitalization in 1980 was one fourth of that in the United States, but seemed to be converging in 1999. Firms’ better access to finance should have therefore promoted entries as a result of the better capacity to pay the fixed entry cost, as well as to an increase in the value of exports by incumbent firms. At the aggregated level, this should have led to a large increase in the number of bilateral trade relationships, especially in industries that are more dependent on external funds. It seems therefore puzzling to see that the number of bilateral trade relationships remain so stable, even in the nineties.
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