This paper develops a new international trade model with capital market imperfections and endogenous borrowing costs in general equilibrium. A key element of our model is that firm heterogeneity arises from the interaction of credit constraints at the firm-level with financial frictions at the country-level. Producers differ in pledgeability of sales which results in firm heterogeneity, if financial institutions are imperfect. We show that endogenous adjustments of capital costs represent a new channel that reduces common gains from globalization. Trade liberalization increases the borrowing rate, leads to a reallocation of market shares towards unconstrained producers and a larger fraction of credit-rationed firms. This increases the within-industry variance of, sales and reduces welfare gains as consumers dislike price heterogeneity. Our theory is consistent with new empirical patterns from World Bank firm-level data. We highlight that credit frictions are positively related to the degree of product market competition and to the variance of sales across firms.
credit constraints general equilibrium globalization imperfect capital markets welfare