Maria D. Tito and Ruoying Wang | This paper investigates the impact of international trade on input market distortions. We focus on a specific friction, binding borrowing constraints in capital markets. We propose a theoretical model where a firm's demand for capital is constrained by an initial asset allocation and past sales. While the initial distribution of assets induces misallocation if the asset endowment at more productive firms does not fully cover their demand for capital, the dependence of the borrowing constraint from past sales proxies for cross-firm differences in the cost of default, which is empirically higher at larger firms. Overtime, an increase in sales relaxes the borrowing constraint; similarly, shocks to market access{such as opening to trade{contribute to easing the financial constraints, thus accelerating the convergence toward the frictionless allocation. To analyze the empirical relationship between market access and credit frictions, we draw on the annual surveys conducted by the Chinese National Bureau of Statistics (NBS) for 1998 to 2007, and we construct firm-level measures of distortions that control for firm heterogeneity. We find smaller labor and capital distortions across exporting firms; such distortions are even smaller in sectors where firms face lower tariffs or are more dependent on external financing, a proxy for the presence of binding financial constraints. Our empirical analysis also shows that export shocks significantly reduce the dispersion across input returns over time, with the effect mostly occurring at constrained firms. Our findings point to within-sector input reallocation as an important channel to overcome misallocation in open economies.

FRB: Finance and Economics Discussion Series Working Papers

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