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Credit Constraints, Quality, and Export Prices: Theory and Evidence from China

Fan, Haichao and Lai, Edwin L.-C. and Li, Yao Amber (2012): Credit Constraints, Quality, and Export Prices: Theory and Evidence from China.

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Abstract

This paper examines the relationship between the credit constraints faced by a firm and the unit value prices of its exports. The paper modifies Melitz's (2003) model of trade with heterogeneous firms by introducing endogenous quality and credit constraints. The model predicts that tighter credit constraints faced by a firm reduce its optimal prices as its choice of lower-quality products dominates the price distortion effect resulting from credit constraints under the endogenous quality case. However, when endogenous quality choice is not possible under the exogenous quality case, there is an opposite prediction that prices increase as firms face tighter credit constraints. An empirical analysis using Chinese bank loans data, Chinese firm-level data from the National Bureau of Statistics of China (NBSC), and Chinese customs data strongly supports the predictions of the endogenous quality case and confirms the mechanism of quality adjustment: firms optimally choose to produce lower-quality products when facing tighter credit constraints. Moreover, the predictions of the exogenous quality case are supported by using quality-adjusted prices in regression analysis and by using quality variation across firms within the same product.

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