This study documents the implications of financial vulnerability for export diversification in
developing economies. Financial crises, by increasing the incidence of sunk costs of entry
into exporting, reduce firm export dynamics. Financially-vulnerable exporters are not able to
fully realize economies of scale in production and access better-sophisticated technologies.
The number of products and destinations per exporter are therefore likely to decrease in
times of crisis. We use a comprehensive cross-country dataset on export dynamics, with data
covering the 1997-2011 period for 34 developing countries to investigate this issue. Building
on the generalized difference-in-differences procedure proposed by Rajan & Zingales (1998)
to remove any endogeneity bias, the results point to a negative and economically large
effect of financial vulnerability on export diversification.
Financial crises reduce export dynamics disproportionately more in financially dependent
industries. This effect is less pronounced in countries with initially more open capital
account, suggesting that portfolio inflows are good substitutes for underdeveloped domestic
financial markets.