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Credit Constraint, Margins of FDI, and Aggregate Industry Productivity
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| Title:
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Credit Constraint, Margins of FDI, and Aggregate Industry Productivity
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| Author:
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Jiarui Zhang
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| co-Authors:
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Lei Hou
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| Organization:
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Ludwig-Maximilians-Universitat, Muenchen
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| Personal profile:
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| Conference presentation:
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China Regional Development Model: Ten Years of Western China Development
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| Abstract:
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We develop a model of firms’ investment combination decisions under financial constraints (limited wealth) to investigate the impact of credit constraints (limited access to external finance) on firms’ margins of Foreign Direct Investment (thereafter FDI). We explicitly model a bond market in an economy with Melitz-type heterogeneous firms and introduce initial wealth and credit constraint as financial factors in a general equilibrium setting. We show that, on one hand, looser credit constraint leads to lower cutoff productivity for FDI and higher expected profit from both FDI and the whole investment portfolio, and consequently firms are more likely to do FDI (extensive margin); on the other hand, looser credit constraint induces firms’ allocation of initial wealth from bond holding to FDI, thereby results in higher foreign affiliate output (intensive margin). Furthermore, we examine the aggregate industry outcome. We find that firms’ foreign expansions cause selection effect across heterogeneous firms through the competition in bond market and labor market. By crowding out the least productive firms from producing domestically, the selection effect brings aggregate productivity gains. We also predict that looser credit constraint will reinforce the selection effect and result in more gains in aggregate productivity. Based on theoretical analysis, we give policy implications to promote internationalization of firms by financial institution reforms.
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| Full-text paper link:
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Corporate Bond, Margins of FDI and Aggregate Industry Productivity.pdf
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