Credit Constraints and Export Prices: Theory and Evidence from China

This paper examines how credit constraints affect unit value export prices and the relation between export prices and firm productivity. The model extends Melitz (2003) by introducing endogenous quality of variety, credit constraints as well as marketing costs to a heterogeneous firm trade model. There are three key findings. First, there exists a positive relationship between firm productivity and export prices because the quality effect (via higher-quality input) dominates the adjustment of marginal cost. Second, more binding credit constraints (or less credit accesses) decrease optimal prices set by the firm as the quality effect dominates the price distortion due to misallocation of upfront costs between variable and fixed costs. Third, if quality was homogeneous across firms, completely opposite impacts would have occurred: there was a negative correlation between prices and productivity, and prices increased as more stringent credit constraints (or lower level of financial development) were faced by firms. The empirical application to Chinese bank loans data, Chinese firm-level data from National Bureau of Statistics of China (NBSC), and Chinese Customs data strongly supports the theoretical predictions from the heterogeneous-quality model, and we find a significant impact of credit constraints on export prices, indicating the prevalence of heterogeneous quality across firms.