Trade, Innovation and Firm Financing

While the trade literature has tended to view export activity and innovation as complementary activities, we present evidence that financial constraints are a reason the two activities can act as substitutes for small exporters. In particular, we find that small exporters have lower expenditure on R&D than comparable non-exporters, and we find a corresponding pattern in the leverage ratio of the capital structure of small firms. A model that combines firm decisions regarding the amount of innovation, exporting, and endogenous financial capital structure is able to account for these empirical findings. The model implies that small firms are unable to fully reap the gains from exporting due to financial constraints, as they reduce R&D to finance the costs of export participation.