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Credit constraints, endogenous innovations, and price setting in international trade

Carsten Eckel () and Florian Unger

Discussion Papers in Economics from University of Munich, Department of Economics

Abstract: We introduce credit frictions motivated by moral hazard in a general equilibrium model of international trade with two dimensions of heterogeneity and endogenous investments. Firms’ competitiveness consists of capabilities to conduct process and quality innovations at low costs, whereas investment outlays have to be financed by external capital. We show that the scope for vertical product differentiation in a sector determines how credit tightening affects investment and price setting. Consistent with recent empirical evidence, our model rationalizes positive as well as negative correlations of firm-level FOB prices with financial frictions and variable trade costs. Faced with an increase in the borrowing rate, producers reduce both types of innovation resulting in opposing effects on marginal production costs and prices. In general equilibrium, financial frictions intensify quality-based (cost-based) sorting of firms if the scope for vertical product differentiation is high (low). Consequently, credit tightening leads to firm exit, increased innovation activity among existing suppliers, and welfare losses that are larger in sectors with low investment intensity.

Keywords: international trade; external finance; credit constraints; moral hazard; quality; innovation; product Prices. (search for similar items in EconPapers)
JEL-codes: F12 G32 L11 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ino and nep-int
Date: 2015-05-21
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Working Paper: Credit constraints, endogenous innovations, and price setting in international trade (2016) Downloads
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