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

Global value chains (GVCs) allow firms to produce and export final goods, or to perform only intermediate stages of production by processing imported inputs for re-exporting. We examine how financial constraints determine companies’ position in GVCs and how this position 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 sources and pays for imported inputs), and pure-assembly processing trade (processing firm receives foreign inputs for free). Conducting more steps of the supply chain increases not only value added, but also profits. However, it requires more working capital because it entails higher up-front costs. As a result, credit constraints restrict firms to low value-added stages of production, and preclude them from pursuing more profitable opportunities. Financial frictions thus affect the organization of GVCs across firms and countries, and inform optimal trade and development policy in the presence of trade in intermediates. Global supply networks may enable more firms in developing countries to share in the gains from trade.