Harmful Procompetitive Effects of Trade in Presence of Credit Market Frictions

Abstract

We explore the consequences of international trade in an economy that encompasses technology choice and an endogenous distribution of markups due to credit market frictions. We show that in such an environment a gradual opening of trade may-but not necessarily must-have a negative impact on productivity and overall output. The reason is that the pro-competitive effects of trade reduce markups and hence make access to credit more difficult for smaller firms. As a result, smaller firms-while not driven out of the market-may be forced to switch to less productive technologies.

Innovation and trade in the presence of credit constraints

“…In a first step, we examine the effect of tariff cuts between 2006 and 2010 on the probability of being credit‐constrained in 2010. For this, we follow Foellmi and Oechslin (2020) who used our data set for motivating empirical evidence.…”

“…Although entrepreneur i has a domestic monopoly, he faces a competitive fringe by Northern producers and cannot set a price above τ when supplying the high quality and τ / q when supplying the low quality. We assume that the market is sufficiently integrated such that all entrepreneurs face the competitive fringe (for cases with intermediate values of τ , see Foellmi and Oechslin 2020).…”

“…The reason for an upper bound on borrowing is the imperfect enforcement of credit contracts. Following Foellmi and Oechslin (2020), we assume that—in case of default—borrower i loses only a fraction λ ∈ (0, 1] of the current firm revenue, p ( y i , q i ) y i . Hence, the parameter λ indicates how well credit contracts can be enforced.…”

Financial Frictions and International Trade

“…Indeed, Bonfiglioli, Crinò, and Gancia (2019) show that financial frictions can discourage entering firms from investing in risky but innovative projects. In similar spirit, Foellmi and Oechslin (2020) show that in the presence of financial frictions opening to trade may force firms to switch to less productive (traditional) technologies.…”

“…Innovation Another channel through which frictions in financial markets affect international trade is by distorting firms' technology and innovation decisions, as documented by Egger and Keuschnigg 2015, Foellmi, Legge, and Tiemann 2015, and Faustino and Matos 2015. To the extent that exporting is dependent on innovation, the finance-intensive nature of R&D and innovation activities implies this is channel may amplify the distortionary impact of credit market frictions.…”