Firms and Credit Constraints along the Global Value Chain: Processing Trade in China

Abstract

Abstract. Global value chains allow firms to not only trade in final goods, but to also conduct intermediate stages of production by processing imported inputs for re-exporting. This paper examines how financial constraints determine companies ’ position in global supply chains, and how this choice affects profitability. We exploit matched customs and balance-sheet data from China, where exports are classified as ordinary trade, import-and-assembly processing trade (processing firm pays for imported inputs), and pure-assembly processing trade (processing firm receives foreign inputs for free). We establish two main results. First, profits, profitability and value added fall as exporters orient sales from ordinary towards processing trade, and from import-and-assembly towards pure assembly. Second, less financially constrained firms perform more ordinary trade relative to processing trade, and more import-and-assembly relative to pure assembly. We rationalize these patterns with a model that incorporates credit constraints and imperfect contractibility in companies ’ export decisions. Our results imply that global production networks allow more firms in developing countries to share in the gains from trade- firms that could otherwise not transact internationally. However, limited access to capital restricts firms to low value-added stages of the supply chain and precludes them from pursuing more profitable opportunities. Financial frictions thus affect the organization of production across firm

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