Credit Constraints and Zero Trade Flows : The Role of Financial Development

According to the recent literature on finance, financial development generates a larger value of trade flows. Nevertheless, whereas access to capital has much increased during the last two decades, trade economists tell us that the number of bilateral trade relationships remained unchanged or increased at a much lower rate. This paper investigates the role of financial development on the intensive and extensive margins of trade. We first develop theoretical expectations about the influence of finance on trade, and then test our predictions using a database that reports bilateral trade flows data for 60 exporting and importing countries and 26 manufacturing industries for the period 1990-2000. Results confirm that financial development promotes the value of exports, as well as the probability that a bilateral trade relationship is established, especially in industries that heavily rely on external finance. We also show that 84% of the overall marginal effect of finance is channeled through the intensive margin, but the share of this impact that can be attributed to the extensive margin increases with industry’s dependency on external funds. Finally, results indicate that the relationship between finance and exports is non-linear: a better development of the local financial market emphasizes the relationship between finance and trade; this is especially true at the extensive margin level. ∗Corresponding author, TEAM Paris 1 Panthéon-Sorbonne University and CNRS, Maison des Sciences Economiques, 106-112, Bd de l’Hôpital 75647 Paris Cedex 13. Tel : (33) 1 44 07 82 64. Fax : (33) 1 44 07 82 67. Email: [email protected]