This article studies the impact of distortions in the access to international capital markets on competition and productivity. I show that a reduction in these distortions leads to an increase in aggregate productivity through two different channels. First, firms that were previously credit constrained respond to better financing terms by increasing their investment in technology, a reallocation effect. Secondly, non-constrained firms also expand their investment in technology because of increased competition, a pro-competitive effect. I provide evidence for these two channels using firm-level census data from the deregulation of international financial flows in Hungary.

This article develops a heterogeneous firm-dynamics model to jointly study firms’ currency debt composition and investment choices. In our model, foreign currency borrowing arises from a dynamic trade-off between exposure to currency risk and growth. The model endogenously generates selection of productive firms into foreign currency borrowing. Among them, firms with high marginal product of capital use foreign loans more intensively. We assess econometrically the model’s predicted pattern of foreign currency borrowing using firm-level census data from the deregulation of these loans in Hungary, calibrate the model, and quantify the aggregate impact of this financing. Our counterfactual exercises show that understanding the characteristics of firms borrowing in foreign currency is critical to assess the aggregate consequences of this financing.

We study empirically and theoretically the effects of international financial flows on resource allocation. Using the universe of firms in Hungary, we show that removing capital controls lowers firms’ cost of capital and increases household consumption, with the latter playing a dominant role. The consumption channel leads to reallocation of resources toward high expenditure elasticity activities—such as services—promoting both the expansion of incumbents and firm entry. A multi-sector heterogeneous firm model replicates these dynamics. Our model shows that nonhomotheticity in consumption can quantitatively account for the reallocation of resources towards services and successfully replicates the dynamics of aggregate productivity following episodes of financial openness.