The Role of Physical and Financial Constraints in Export Dynamics

How do firms' sales interact across markets? Recent empirical work has suggested that foreign and domestic sales are substitutes for firms facing financial and physical capacity constraints. Using a large Spanish firm-level database for the period 1990-2011, we study the interconnections between exports and domestic sales. We provide a new measure to determine if firms face physical constraints based on the capacity utilization of the firm, and document that it is independent of firm fundamentals such as value added and productivity. Then, we built a theoretical framework consistent with the empirical facts presented where firms are heterogeneous across capacity and productivity. A firm facing a binding capacity constraint faces a trade-off between selling on the domestic market or the foreign market, and raises prices in order to take advantage of access to new markets. We establish the prevalence of these anomalous firms, and demonstrate that capacity constrained firms substitute sales across locations.