Financial development and the distribution of trade flows

A strong and positive correlation between financial development (FD from hereon) and total aggregate exports across country pairs has been well established. Recent studies also suggest of heterogeneity in trade cost elasticity across country-pairs and across the distribution of trade flows. The average FD–exports relationship, which studies mostly examine, can therefore mask heterogeneous impact of FD across different levels of exports. To examine this possibility, we utilize the methods of moment quantile regression (MMQR), a novel approach proposed by Machado and Santos Silva (2019) in a panel data context with fixed effects. We find that countries that export the least benefit the most from increases in FD. In fact, the positive FD–exports relationship is driven primarily by country-pairs that trade at the median or lower end of the export distribution. Interestingly, the positive association of the FD–exports relationship breaks down for countries that trade at the highest end of the export distribution (90th percentile). Our results reinforce the argument that FD alleviates fixed costs to exports, but more importantly so, for country-pairs that trade the least.