Financial Frictions, Trade, and Misallocation

We investigate the extent to which financial frictions shape the aggregate effects of a trade liberalization through their impact on aggregate total factor productivity (TFP) and capital misallocation. We study a small open economy populated with heterogeneous entrepreneurs who differ in their productivity and are subject to financing constraints. Individuals choose whether to be workers or entrepreneurs, and entrepreneurs choose whether to export or not. We show how financial frictions distort these decisions and aggregate TFP. We calibrate the model to match key features of Chilean plant-level data and use it to quantify the TFP losses due to misallocation. We then investigate how the presence of financial constraints affects the output and TFP gains from trade liberalization. We find that lowering trade barriers has a stronger positive effect in less financially developed economies. The higher profits that result from trade liberalizations allow firms to accumulate assets and relax their credit constraint, which is particularly valuable in economies where firms are severely constrained.