| Abstract: |
Global supply chains allow firms in developing countries to share in the gains
from trade by conducting either ordinary or processing trade. This paper
examines how financial constraints affect companies’ choice of trade regime
and ultimately profitability. We exploit matched customs and balance sheet
data from China, where processing trade is further divided into
import-and-assembly (processing firm pays for imported inputs) and pure
assembly (processing firm receives imported inputs for free). We establish two
main results. First, profits, profitability and value added fall as exporters
orient sales from ordinary towards processing trade, and from
import-and-assembly towards pure assembly. Second, less financially
constrained firms perform more ordinary trade relative to processing trade,
and more import-and-assembly relative to pure assembly. We rationalize these
patterns with a model that incorporates credit constraints and imperfect
contractibility in companies’ choice of trade regime. Our results imply that
limited access to capital restricts firms to low value-added stages of the
supply chain and precludes them from pursuing more profitable opportunities.
Financial frictions thus affect the organization of production across firm and
country boundaries, and inform optimal trade policy in the presence of trade
in intermediates. |