ESA Economia Internazionale Lecture 8 Giorgia Giovannetti Professor of Economics, University of Firenze

Plan of the course/lectures Lectures (tentative) 14/9 Introduction: globalization 15/9 Introduction, 2 21/9 Ricardo: an introduction (Marvasi) 22/9 Measuring Globalization, Indicators 28/9 Measuring globalization and specialization, Indicators 2 29/9 Overview trade models 5/10 Overview trade models (Bernard et al 2007; 2011) 6/10 Overview- end (new new trade) 12/10 Trade models: Ricardo and comparative advantage 13/10 Ricardo and comparative advantage, 2 /H-O, intro 19/10 Trade models: H-O 20/10 Trade models: H-O,2/exercises 26/10 Trade and Imperfect competition 27/10 Trade and imperfect competition 2/11 Geography models/gravity 3/11 Hysteresis, Heterogeneous firms 9/11 Trade policy: TTIP 10/11 EU development Policy 16/11 EU development Policy 17/11 FDI and Multinationals: OLI theory 23/11 FDI and Multinationals Offshoring/trade in tasks 24/11 China and India (BRICS) 30/11 Granularity and aggregate shocks 1/12 212

New New Trade Theory B J RS Chaney Melitz Helpman Hopenhayn

Summary: Firm Heterogeneity, Motivation The Helpman-Krugman model features universal exporting by firms in a differentiated product industry: – every brand is produced by a single firm in just one country, which exports its output everywhere else in the world; – using non-iceberg transport costs or a different demand system can change this outcome. This does not provide a good description of firm-level data. In the data: – only a small fraction of firms export; – exporters sell most of their output domestically; – exporters are bigger than non-exporters; – exporters are more productive than nonexporters; – exporters pay higher wages than nonexporters.

Summary: Share of manufacturing firms that export CountryYearExporting firms, in per cent U.S.A Norway France Japan Chile Colombia Very few plants/firms export: – 18% of U.S. firms in 2002 (the proportion of exporting plants is higher as exporting plants are more likely to be owned by multi-plant firms) This number has been increasing steadily over the past 10 years: 14.6% of U.S. firms in 1992 – Same pattern holds for both developed and developing countries 17.4% of French firms in 1986

Share of exports of manufactures CountryYearTop 1% of firmsTop 10% of firms U.S.A Belgium France Germany Norway UK

A summary Potential Entrants Entrants Randomly draw their productivity levels Lowest productivity entrants High productivity entrants Leave immediately Pay fixed production cost and serve the domestic market Pay irreversible investment to enter unable to earn positive operating profit Flow chart 1: Productivity uncertainty and firm entry/exit

New New Trade Theory Costs Export fixed cost Unit trade cost (“iceberg”) Most productive firms export – use more resources – drawn from less productive firms – least productive exit Industry average productivity rises

Heterogeneous Firms Domestic survival productivity threshold in autarky Domestic and export survival thresholds in trade (export threshold higher due to trade costs) Domestic survival threshold higher in trade than in autarky Industry more productive – due to intra-industry resource reallocation – no change in individual firms’ productivities

Effects of trade Probability Firm level Productivity Export threshold Domestic threshold open Domestic threshold autarky Exporters Purely domestic firms Contract Leave Expand Exiters

Heterogeneous Firms Implications – Trade improves industry productivity relative to autarky – additional source of gains from trade – but number of varieties available may rise or fall. – Improved technology in one country may lead to reduced industry efficiency in its trading partner (but still gains from trade) – Can get specialization if technology or market size differences large enough – Supply responds to demand through entry and exit

Heterogeneous Firms Why do firms differ in productivity? luck managerial ability/entrepreneurship producing products of different quality What leads to a better productivity distribution? human capital Do more productive firms export – or does exporting make firms more productive? Evidence (for developed countries) suggests former.

Heterogeneous Firms & Many Countries Distinguish “extensive margin” of trade – number of products exported and number of markets exported to; “intensive margin” of trade – volume of a particular product exported to a particular market. Trade liberalisation can affect both margins

14 New New trade theory Challenge 1: Producer Heterogeneity Vast heterogeneity across plants and firms – Productivity, capital intensity, skill intensity, etc. Heterogeneity within industries is often as large as heterogeneity across industries

15 Challenge 2: Excess Reallocation There is ongoing job creation and job destruction in all industries The net change in industry employment is small relative to the total amount of job creation and destruction There are reallocations of resources within industries (across firms) as well as between industries

16 Challenge 3: Trading is Rare Within industries, some firms export and many others do not – True for both net exporting and net importing industries Within industries, exporters are different – Larger, more productive, pay higher wages, etc. Multinationals are also larger and more productive than firms that serve only the domestic market

17 Challenge 4: Exporting  Productivity? Why are exporters more productive? – High productivity  Exporting? – Exporting  High Productivity? Strong evidence that good firm performance leads to exporting (selection) US : Bernard and Jensen (1999) o Taiwan : Aw, Chen and Roberts (2001) Mixed evidence on exporting leading to better firm performance (learning by exporting) o Columbia, Mexico and Morocco : Clerides, Lach and Tybout (1998) find little evidence

18 Challenge 5: Liberalization and Reallocation Trade liberalization results in exit by low- productivity firms and changes in industry composition as high-productivity firms expand to enter export markets E.g., Pavcnik (2002): 19.3 percent productivity growth in Chilean manufacturing during o 6.6 percent from increased productivity within plants o 12.7 percent from reallocation of resources from less to more efficient producers

Summary: Interpreting the evidence An obvious question at this point is: Do differences in performance generate selection into exporting, or does exporting generate differences in performance? Not straightforward to tease out empirically: One can look at the timing of productivity changes and exporting (does exporting lag productivity improvements or vice versa) But notice that firms can select into exporting because they anticipate that their productivity is in an upward trend (Costantini and Melitz, 2008) Strong evidence for self-selection of more productive firms into exporting Mixed evidence for “learning-by-exporting”

Caveats Exogenous causality from either export status or productivity is suspect – New evidence shows that firms make joint decisions concerning both export status and technology choice: Verhoogen (2009, QJE): quality upgrade and exports in Mexico Bustos (2010, AER): new exporters in Argentina spend more on technological upgrades Lileeva and Trefler (2010, QJE): similar for Canada “Death” and Exporting: Is it just that low-productivity firms are more likely to die and these tend to be non- exporters? No. Conditional on a full set of industry and firm controls (productivity, size, capital-labor ratio,...), export status is still associated with a significant 5-6% reduction in probability of death

New new trade theory Evidence suggests that successful theoretical frameworks for studying firms and the decision to export should include two features: 1. Within sectoral heterogeneity in size and productivity 2. A feature that leads only the most productive firms to engage in foreign trade Melitz model 2003

22 Heterogeneous Firms Melitz (2003) follows Hopenhayn (1992). Individual firms each have a randomly chosen productivity parameter, as well as differentiated products Bernard, Redding, and Schott (2005) put Melitz model in the HO model

23 Outline of the Melitz (2003) Model Extension of the “Krugman model” Firms use labor to produce varieties of manufacturing good Firms enter a market by paying a sunk entry cost Firms observe their productivity j from a distribution g(  ) There is a fixed cost of producing and a fixed cost of exporting Firms decide whether to produce or exit the industry If firms produce, they decide whether to serve only the domestic market or also to export Exogenous probability of firm death