Entering the export market entails incurring costs such as market research costs, market development and distribution channel development costs. A forward looking manager would weigh these sunk costs incurred during market entry, against the future stream of income. Therefore, entering the export market becomes a question of which firms have the ability to undertake this investment.
As per the Melitz model (2003), firms self select into the export industry if their productivity is high as it enables them to undertake the investment associated with new market entry. The Melitz model assumes only one factor of production; labor, whose supply is inelastic at the aggregate level. In this paper, I consider the other factor of production; capital, the availability of which might constrain a firm’s entry into the export market. In the presence of financial frictions, a firm’s investment decision will not be independent of its financing decision. Therefore, even a highly productive firm might be inhibited from entering the export market if it is constrained by its finances.
This paper studies the effect of financial constraints on a firm’s export participation decision. In the literature on export participation much emphasis has been laid on the importance of firm’s productivity in its export participation decision (Roberts & Tybout (1997), Bernard, Eaton et al (2003)). All these models are predicated on the assumption that capital is available to the firms at the rate equal to its marginal product. In developing countries, it has been evidenced that the marginal product of capital is higher than the prevalent rate of interest (Caselli & Feyrer (2007)). As most emerging and developing economies are fueling their growth by exports, it is imperative to investigate the importance of credit constraint on export participation.
India underwent a spate of industrial, trade, banking and financial sector policy changes in the 1990s. This changed, among other things, the financial landscape for industries in India. At the same time, India also experienced a healthy growth in exports. This paper investigates the relation between these two phenomena. Was the growth in exports a fall out of trade liberalizations only? Or did financial liberalization help ease the credit constraint and thus affect the export participation of the firms? Did the liberalization manifest itself as increased number of exporters or as increased intensity of exports by the same exporters? These are some of the questions this paper tries to investigate using financial data of Indian firms.
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