are higher. Thus, the marginal benefits of trade liberalization in lowering prices and increasing real wages are reduced if much reallocative work has already been done through a well-functioning domestic financial sector. In terms of the potential linkage between exports and credit constraints, improvements in the relative ability to pledge exports to creditors amplify the benefits of trade liberalization. A further insight of the paper is that even in financial autarky the financial development of not just the domestic economy but also its trading partner can play a role in determining the real wages and the efficiency of domestic production. In particular, domestic financial sector reforms in one economy can be exported via the trade channel putting downward pressure on foreign real wages.

The value added of the approach adopted below is to provide a framework which allows analysis of the macroeconomic implications of reforms in one area, for example the domestic financial sector, conditional on other policy variables, for example the degree of access to international goods markets. Using this modeling approach to assess whether the interactions between these different reform measures have quantitatively important empirical effects is an important next step. In the rest of the paper, Section 2 first discusses the motivation and related literature. Section 3 then provides an overview of the modeling approach focusing on the credit constraints that entrepreneurs face. Section 4 provides details of the model with Section 5 analyzing the steady state in trade and financial autarky to emphasize the key mechanisms in the model. Section 6 then opens up the economies to international goods trade. Section 7 concludes including a discussion of further research and empirical implications.

# **2 Motivation and related literature**

## **2.1 Motivation**

The modeling approach which I adopt is driven by two main features: first, the importance of addressing firm heterogeneity in any analysis of trade and domestic financial sector reforms and, second, the importance of analyzing the interactions of these two reforms. As surveyed in, for example, Bernard et al. (2007a), recent heterogeneous firm models of international trade are motivated by the observation that exporters tend to differ from non-exporters in important ways, for example being larger and more productive. Surveys indicate that only a limited subset of plants export, for example around 20% in the 1991 US Census of Manufactures (Bernard et al., 2003). There is also empirical support for the self-selection of higher productivity firms into exporting rather than a causality running from exporting to higher productivity, eg Clerides et al. (1998). At the same time, financial constraints vary across firms and recent firm-level data suggests that the degree of financial constraints faced by firms depends on their export status. For example, using Spanish data Campa & Shaver (2002) find exporters to be less liquidity constrained whilst for UK data Greenaway et al. (2007) show that being an exporter improves a firm’s liquidity and lowers its leverage.<sup>2</sup> This linkage from export status to a firm’s financial constraints is in addition to the growing empirical evidence on the effects of financial constraints on export levels and patterns.<sup>3</sup> Indeed, the analysis of

> 2Also, using World Bank survey data from developing and emerging economies Beck et al. (2006) find that the problem of bank corruption as a constraint to finance is less of a problem for exporters.

> 3See, for example, the sector-level analysis in Manova (2006).

3