DP11727 Credit constraints, endogenous innovations, and price setting in international trade

Author(s): Carsten Eckel, Florian Unger
Publication Date: December 2016
Keyword(s): credit constraints, external finance, innovation, International Trade, moral hazard, product prices, Quality
JEL(s): F12, G32, L11
Programme Areas: International Trade and Regional Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=11727

This paper analyzes the effects of credit frictions on within-firm adjustments and selection into exporting when both cost-based productivity and product quality matter for the success of a producer. Our model shows that whether FOB prices are positively or negatively correlated with credit frictions and variable trade costs depends on the sectoral R&D intensity. If the latter is high, prices decrease in credit and trade costs, and vice versa. Furthermore, we show that the aggregate effects of financial shocks also depend on the R&D intensity. Stronger credit frictions lead to firm exit, inefficiently high innovation activity among existing suppliers, and welfare losses that are larger in sectors with low R&D intensity. To analyze the effects of credit frictions, we allow for both cost-based and quality-based sorting in a general equilibrium model of international trade. Producers differ in capabilities to conduct process and quality innovations, and external finance is needed for investments.