Kalina Manova and Zhihong Yu
The past 20 years of globalisation have witnessed a dramatic expansion in the fragmentation of production across countries. Firms today can not only trade in final goods, but also conduct intermediate stages of manufacturing by importing foreign inputs, processing and assembling them into finished products, and re-exporting these to consumers and distributors abroad. While processing trade contributes just 10% of EU exports, at over 50% it has been a major driving force behind the rapid growth of Chinese exports (Cernat and Pajot 2012).
In this Nottingham School of Economics working paper, published in the Journal of International Economics, Kalina Manova and Zhihong Yu examine matched customs and balance-sheet data from China to study how financial factors affect firms participation in global value chain through processing trade. The authors conclude that international production networks allow more firms to share in the gains from trade - firms that could otherwise not export at all. However, limited access to capital restricts manufacturers to low value-added stages of the supply chain and precludes them from pursuing more profitable opportunities. Exploiting multiple sources of variation in the data to establish causality, Manova and Yu consistently find that financial frictions force companies into the less profitable processing mode, and the least attractive pure-assembly regime in particular. As a result, credit-constrained firms, and financially under-developed countries as a whole, might be stuck in low value-added stages of the supply chain and unable to pursue more attractive opportunities. Strengthening capital markets might thus be an important prerequisite for moving into higher value-added, more profitable activities.
Journal of International Economics, "How Firms Export: Processing vs. Ordinary Trade with Financial Frictions", by Kalina Manova and Zhihong Yu.
http://dx.doi.org/10.1016/j.jinteco.2016.02.005
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Posted on Friday 1st July 2016