Firms and Credit Constraints along the Value-Added Chain: Processing Trade in China
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.
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