Trade, Finance and Endogenous Firm Heterogeneity

We study how financial frictions affect firm-level heterogeneity and trade in a model where productivity differences across monopolistically competitive firms are endogenous and depend on investment decisions at the entry stage. By increasing entry costs, financial frictions reduce the exit cutoff thereby lowering the value of investing in bigger projects with more dispersed outcomes. Hence, credit frictions make firms more homogeneous and hinder the volume of exports both along the intensive and the extensive margin. Export opportunities, instead, shift expected profits to the tail and increase the value of technological heterogeneity. We test these predictions using comparable measures of sale dispersion within 365 manufacturing industries in 119 countries, built from highly disaggregated US import data. Consistent with the model, financial development increases sale dispersion, especially in more financially vulnerable industries; sale dispersion is also increasing in measures of comparative advantage. These results are quantitatively important for explaining the effect of financial development and factor endowments on export sales.