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Trade Liberalization with Endogenous Borrowing Constraints

  • Alessandro Dovis

    (University of Minnesota)

  • Wyatt Brooks

    (University of Minnesota)

A recent empirical literature has documented that credit availability is a significant barrier for firm-level exports. We develop a dynamic general equilibrium trade model with heterogeneous monopolistic competitive firms and imperfect credit markets due to limited contract enforceability. We show that this model is consistent with the findings of the empirical literature. We ask if credit constraints reduce gains from a tariff reduction. In a calibrated example, we find that the percentage change in steady state consumption is in an economy with limited enforcement is approximately equal to the change in an equivalent one with perfect credit markets. We conclude that the presence of financial constraints at the firm level does not reduce the aggregate gains from a tariff reduction. This is because the credit constraints respond to profit opportunities. When tariffs are reduced, exporters are more profitable, which allows them to borrow more. In an equivalent economy where credit constraints are exogenous, there is a 10% smaller increase in consumption from tariff reduction.

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Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 631.

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Date of creation: 2011
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Handle: RePEc:red:sed011:631
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