Financial Development , Endogenous Dependence on External Financing , and Trade ∗

The influential papers on the effect of credit constraints on growth and international trade (Rajan and Zingales, 1998; Manova, 2013) tend to assume that asset tangibility and the share of external borrowing are exogenous industry characteristics, which are timeand country-invariant. In the finance literature, however, the share of external borrowing is viewed as endogenous and dependent on the amount of collateral the firm can provide (and thus implicitly on its asset tangibility). In order to compare these approaches, I use Compustat Global data, to construct the measures of asset tangibility and external borrowing for 25 industries in 10 countries between 1987 and 2006. I find that (i) the share of external borrowing increases in asset tangibility, and (ii) the rankings of asset tangibility and the share of external borrowing vary significantly across countries. Further, I develop a theoretical model that incorporates financial frictions into an otherwise standard trade model to investigate the impact of financial development and asset tangibility on the demand and supply of external finance and export. The model offers theoretical predictions that are consistent with and provide an intuition for the above results. Furthermore, contrary to the results of Manova (2013), both the model and my empirical results demonstrate that industries with more tangible assets export relatively more from countries with higher levels of financial development. JEL classification: F10, F14, G20, O14, O16