Asymmetric effects of financial development on export price and quality across countries

Abstract

A large body of literature has emphasized the importance of financial development (FD) for economic growth and exporting. 1 Nonetheless, recent empirical findings have shown that FD does not affect the growth of low-income countries. 2 These findings raise questions about how FD affects exporting, and whether FD benefits all exporting countries equally.These aforementioned questions motivate us to explore the effects of FD on two essential components of exporting: export prices and export quality. 3 We find that these effects are highly asymmetric across countries, and we provide an explanation for these asymmetries. Additionally, our findings suggest that improving the quality of financial institutions alone is unlikely to boost quality or lower export prices in low-income countries.Theoretically, we provide a unifying framework to explain why and how the effects of FD on export quality and prices differ across countries. A key component of our model is based on the AbstractWe derive two novel predictions: financial development has a more pronounced effect on quality in countries with greater labor productivity, and its effect on export prices is U-shaped in labor productivity. We confirm our predictions empirically and show that the negative effect of financial development on export prices is greatest in middle-productivity countries, while its positive effect on quality is strongest in the most productive countries. Our findings contribute to the literature on the poverty trap: we argue that improving the quality of financial institutions alone is unlikely to boost quality or lower prices of the poorest countries. | 595 CHOI and LUGOVSKYYcomplementarities between different inputs-capital, labor productivity, and entrepreneurial talentin the production function of quality. Building on Verhoogen (2008), we employ a discrete choice model, where the production function of quality contains the elements of O-ring technology (Kremer, 1993). We extend it in two important dimensions: first, we introduce the liquidity constraints of exporting firms in the model and assume that the cost of borrowing decreases in FD. 4 Second, in line with the labor search literature, 5 we assume a positive correlation between labor productivity and entrepreneurial talent across countries.The model provides three testable predictions: (i) controlling for quality, better FD decreases export prices; (ii) FD has a positive effect on export quality, and more so in countries with higher labor productivity, and (iii) for sufficiently large parameter regulating the share of capital in the production function, the effect of FD on export prices is U-shaped in labor productivity.The first effect is the most straightforward: given the same set of inputs, a lower cost of borrowing reduces the total cost and sequentially the price. The second effect is due to the super-modularity of the production function of quality in inputs. As a result, any reduction in the variable production cost-including lower borrowing costs owing to better developed financi...

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