_a_ = 3 _._ 4 and the minimum productivity _φ_ min = 0 _._ 2. The discount factors of households and entrepreneurs are set at _β_ = 0 _._ 96 and _δ_ = 0 _._ 92 respectively (yielding a steady state annual real interest rate of 4%). The share of household labor costs in total labor costs is set at _ζ_ = 0 _._ 985 following Bernanke et al. (1999) since entrepreneurial production rather than their labor income is the focus of the model. For simplicity the fixed costs of domestic and export production are set equal to one composite labor unit in both countries. Labor endowments are identical across countries with the masses of labor and entrepreneurs which rescale the results set at _L_ = _L_<sup>_∗_</sup> = 100 and _M_ = _M_<sup>_∗_</sup> = 20 giving an export propensity of producers of around 30% when variable trade costs _τ_ = 1 _._ 4.<sup>28</sup> This compares, for example, to estimates of around 21% of plants in the 1991 US Census of Manufactures Bernard et al. (2003). In developing economies, Aitken et al. (1997) find that around 27% of a 1986 and 1989 sample of Mexican manufacturing plants were exporters whilst the samples of Clerides et al. (1998) have 35% of Moroccan plant as exporters (1984-1991), 9.5% of Colombian plants (1981-1991) and a comparable number of 23% for Mexican plants (1986-1990).

# **6.2.2 Impact of reforms to home financial sector**

Before considering trade and financial reform interactions I first illustrate how home financial sector reforms affect both the home and the foreign economy for given trade costs. This aids understanding of the mechanisms through which the different reform policies interact. I compare the steady state equilibria with goods trade (subject to symmetric iceberg trade costs _τ_ = _τ_<sup>_∗_</sup> = 1 _._ 4) under different values of home financial development (ie varying the credit multipliers _θ_ and _μ_ ) with foreign credit multipliers constant at _θ_<sup>_∗_</sup> = 0 _._ 5 and _μ_<sup>_∗_</sup> = 1.

**Entrepreneurial propensity to produce and export** As illustrated in Figure 3, as the home credit multipliers rise the domestic production productivity cutoff in home rises via the same channels as in autarky (ie increasing investment via the intensive margin with the resulting real wage rise increasing costs and causing lower productivity firms to drop out of production).<sup>29</sup> The higher wage costs also cause the export production productivity cutoff in home to rise. In the foreign economy the impact of changes in _θ_ all take place via the trade channel. In particular in this general equilibrium set-up home financial development affects not just home export propensity (which has been emphasised in, for example, Chaney, 2005; Manova, 2006) but also the export propensities of foreign firms, as is also the case in the three-country analysis of Chor et al. (2008).

In the home economy the rise in _θ_ affects the export propensity (ie the ratio _<u>φx/φd</u>_ ) through two channels. The first is an ambiguously signed partial equilibrium effect via the relative financing constraints on domestic and export revenues. The second effect is through the general equilibrium effect via the real exchange rate in reducing the relative demand for foreign relative to home intermediates . In the home economy the net effect in this illustration is that the propensity to export increases with home financial development

> 28Such trade costs are of similar order to the 44% estimate of border-related trade barriers in the representative trade costs outlined in Anderson & van Wincoop (2004).

> 29It can also be shown analytically that the domestic production productivity cutoff in the home economy rises with an increase in the relative pledgeability of exports, _μ_ .

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