Heterogeneous Firm Model Research Articles

The welfare impacts of a revenue-neutral switch from tariffs to VAT with intermediate inputs and a VAT threshold

The debate about replacing tariffs with value-added tax (VAT) in developing countries has paid little attention to the role of VAT as an input tax on the informal sector and has overlooked the usefulness of changing the VAT threshold in a revenue-neutral switch from tariffs to VAT. This paper contributes to the literature by addressing these two issues via a heterogeneous firm model of a small open economy with endogenous firm entry and VAT compliance. The results found indicate that the VAT collected on intermediate inputs consumed by the informal sector not only reduces the benefits of evading VAT, but also diminishes the production distortion between the formal and the informal sectors. The use of a change in the VAT threshold to offset lost tariff revenue leads to welfare gains; however, the source of such gains is different from that of a change in the VAT rate. While an increase in the VAT rate expands informality, a revenue-equivalent decrease in the VAT threshold reduces informality. These novel results suggest that the VAT threshold plays an important role in the design of revenue-neutral tax reforms.

Supply Chains and the Internalization of SMEs: Evidence from Italy

This paper explores the impact of being part of a supply chain on the internationalization of firms. We show that even small and less productive firms, if involved in production chains, can take advantage of reduced costs of entry and economies of scale that enhance their probability to become exporters. The empirical analysis is carried out on an original database, obtained by merging and matching balance sheet data with data from a survey on over 25,000 Italian firms, largely SMEs, which include direct information on the involvement in supply chains. We find a positive and significant impact of being part of a supply chain on the probability to export and on the intensive margin of trade. The number of foreign markets served (the extensive margin), on the other hand, does not seem to be affected. We also investigate whether being in different positions along the chain, i.e. upstream or downstream, matters and we find that downstream producers tend to benefit more. Our results are robust to different specifications, estimation methods, and to the inclusion of the control variables typically used in heterogeneous firm models.

Welfare and Trade without Pareto

Quantifications of gains from trade in heterogeneous firm models assume that productivity is Pareto distributed. Replacing this assumption with log-normal heterogeneity retains some useful Pareto features, while providing a substantially better fit to sales distributions-especially in the left tail. The cost of log-normal is that gains from trade depend on the method of calibrating the fixed cost and productivity distribution parameters. When set to match the size distribution of firm sales in a given market, the log-normal assumption delivers gains from trade in a symmetric two-country model that can be twice as large as under the Pareto assumption.

Heterogeneous firm-level responses to trade liberalization: A test using stock price reactions

This paper presents novel empirical evidence on key predictions of heterogeneous firm models by examining stock market reactions to the Canada–United States Free Trade Agreement of 1989 (CUSFTA). I derive testable predictions for a class of models based on Melitz (2003). Using the uncertainty surrounding CUSFTA's ratification, I show that the pattern of abnormal returns of Canadian manufacturing firms was strongly consistent with predictions related to export (U.S.) tariff reductions, but less so with predictions related to import (Canadian) tariff reductions. Lower Canadian tariffs did have an effect through the implied reduction in intermediate input tariffs, however.

Implications of Financial Development of the South for Trade and Foreign Direct Investment from the North

AbstractUsing a North–South model of heterogeneous firms, the paper investigates the effects of the financial development of the South on the choice of international entry mode (export vs foreign direct investment [FDI]) of Northern firms. Such development facilitates the entry of local firms and thus intensifies product market competition. As a result, the intensive margins, extensive margins and total sales from export or FDI of Northern firms are all reduced. The paper provides conditions that determine whether export or FDI is affected more significantly. The results generate empirically testable hypotheses.

Exports, Investment and Production Growth: A Dynamic Heterogeneous Firm Model with Learning and Entry Costs

We analyze a fi rm's joint decision to export and invest using a model that incorporates the essential features of self-selection and learning-by-exporting theories of fi rm-level dynamics. We calibrate the model to 2002-07 Chilean manufacturing plant data and simulate it under different assumptions, finding that neither self-selection nor learning-by-exporting alone can adequately explain the observed cross-sectional relationship between firm level exports and capital, favoring instead a model that allows both mechanisms to work in tandem.

Deforestation, foreign demand and export dynamics in Indonesia

This paper presents a dynamic, heterogeneous firm model of investment in environmental abatement and exporting. The model highlights the interaction between firms' environmental investment and export decisions on the evolution of productivity and export demand in timber manufacturing industries. The model is structurally estimated using Indonesian timber manufacturing data that captures firm-level variation in environmental investment and export behavior. The results suggest that environmental abatement has little impact on productivity dynamics, but does encourage growth in export demand. Counterfactual experiments quantify the impact of policy change on trade and abatement decisions.

A Theory of Trade Liberalization and Innovations with Heterogeneous Firms

This paper extends the firm heterogeneity model of Melitz (2003) by introducing a new concept of endogenous investments in process R&D. The novelty is that if a firm invests more in R&D its expected innovation return hazard rate stochastically dominates the return of less R&D investments. Due to this property, entrants invest more in R&D in response to trade liberalization. As a result, the aggregate productivity is affected by a reallocation of resources to more productive firms and a simultaneous increase in firms' investments in innovations, which is consistent with empirical findings. At the same time the firms' increased R&D investments lead to a sector distribution with a higher right-tail compared to the distribution prior to trade liberalization. Hence, the model gives an explanation for the empirically found differences in the distribution tails among sectors with different trade openness levels. Another advantage of this paper's framework compared to other trade models with innovations is its foundation in and extension of Melitz (2003). It enables most of the heterogeneous firms trade models to be extended by endogenous firm-level R&D in an empirically relevant and analytically tractable way.

A theory of trade liberalization and innovations with heterogeneous firms

This paper extends the firm heterogeneity model of Melitz (2003) by introducing a new concept of endogenous investments in process R&D. The novelty is that if a firm invests more in R&D its expected innovation return hazard rate stochastically dominates the return of less R&D investments. Due to this property, entrants invest more in R&D in response to trade liberalization. As a result, the aggregate productivity is affected by a reallocation of resources to more productive firms and a simultaneous increase in firms' investments in innovations, which is consistent with empirical findings. At the same time the firms' increased R&D investments lead to a sector distribution with a higher right-tail compared to the distribution prior to trade liberalization. Hence, the model gives an explanation for the empirically found differences in the distribution tails among sectors with different trade openness levels. Another advantage of this paper's framework compared to other trade models with innovations is its foundation in and extension of Melitz (2003). It enables most of the heterogeneous firms trade models to be extended by endogenous firm-level R&D in an empirically relevant and analytically tractable way.

Spatial sorting with heterogeneous firms and heterogeneous sectors

The present paper focuses on spatial sorting as a mechanism behind the well-established fact that there is a central region productivity premium. Using a model of heterogeneous firms that can move between regions, Baldwin and Okubo (2006) show how more productive firms sort themselves to the large core region. We extend this model by introducing different fixed costs in terms of capital among firms and sectors. In accordance with empirical evidence, more productive firms are assumed to be associated with a higher fixed cost in terms of capital. As a result, our model can produce sorting to the large regions from both ends of the productivity distribution. Firms with high capital intensity and high productivity as well as firms with very low productivity and low capital intensity tend to relocate to the core. We use Japanese micro data to explore the predictions of the model. Many sectors show patterns that are consistent with two-sided sorting. We also find supportive evidence for our model prediction that two-sided sorting occurs in sectors with a high capital intensity.

How and where to offshore: a productivity comparison at the firm level

Using recent survey data on South Korean firms’ strategies for sourcing intermediate goods from abroad, we investigate whether there exists a productivity premium of offshoring by considering organizational forms (insourcing versus outsourcing) and the income level of offshored countries (North versus South) altogether. Thus, we consider the following four offshoring types: outsourcing from South, insourcing from South, outsourcing from North and insourcing from North. Unlike previous studies, we give particular attention to the comparison between outsourcing from North and insourcing from South and find that firms outsourcing from North are more productive than firms sourcing from their own affiliates in South. We offer three critical conditions to incorporate our empirical findings into the standard firm heterogeneity model: the fixed cost is higher for insourcing than for outsourcing and is higher in North than in South, the headquarters receive a larger share of the final revenue through insourcing than through outsourcing, and sourcing from North guarantees better profitability (or a bigger share) in the market for the headquarters than sourcing from South. Thus, this article contributes to the literature by identifying a new productivity order.

Firm-Level Evidence on Productivity Differentials and Turnover in Vietnamese Manufacturing

This paper examines the relationship between productivity differentials and firm turnover in Vietnamese manufacturing. We utilize firm-level data between 2000 and 2009, including the year 2007, when Vietnam joined the World Trade Organization. Our major findings are twofold. First, the productivity of entrants, survivors and exiters increased simultaneously from 2006 to 2007. This result suggests that the cut-off productivity level increased after trade liberalization. Second, the resource reallocation between firms was facilitated after the liberalization. These findings are consistent with the implications of the recent models of international trade and firm heterogeneity.

Firm Entry and Employment Dynamics in the Great Recession

The 2007-2009 recession is characterized by: a large drop in employment, an unprecedented decline in firm entry, and a slow recovery. Using confidential firm-level data, I show that financial constraints reduced employment growth in small relative to large firms by 4.8 to 10.5 percentage points. The effect of financial constraints is robust to controlling for aggregate demand and is particularly strong in small young firms. I show in a heterogeneous firms model with endogenous firm entry and financial constraints that a large financial shock results in a long-lasting recession caused by a missing generation of entrants.

The Firm Size Distribution Across Countries and Skill-Biased Change in Entrepreneurial Technology

How and why does the firm size distribution differ across countries? Using two datasets covering more than 30 countries, this paper documents that several features of the firm size distribution are strongly associated with income per capita: the entrepreneurship rate and the fraction of small firms fall with per capita income across countries, while average firm employment, the median and higher percentiles of the firm size distribution, and the dispersion and skewness of employment all rise with per capita income. The paper broadens existing evidence on the first three facts to cover more countries and newly introduces the last three to the literature. It then proposes a simple theory of skill-biased change in entrepreneurial technology motivated by recent microeconomic literature that fits with the evidence. For this, it introduces two additional features into an otherwise standard occupational choice, heterogeneous firm model a la Lucas (1978): technological change does not benefit all potential entrepreneurs equally, and there is a positive relationship between an individual's potential payoffs in working and in entrepreneurship. If some firms consistently benefit more from technological progress than others, they stay closer to the frontier, while others fall behind. Because wages rise for all workers, marginal entrepreneurs exit and become workers. Quantitatively, the model fits both the U.S. time series experience and cross-country patterns well.

Foreign entry, quality, and cultural distance: product-level evidence from US movie exports

This paper investigates the effect of quality on foreign entry using data on international movie exports and direct and revealed measures of movie quality. Strict quality sorting is predicted by a model of firm heterogeneity. An alternative model is random entry, in which entry decisions are independent of the movie’s quality. I develop a discrete choice model that allows for both of these extremes as special cases, and use graphical techniques and simulations to compare their predictions to the data. I then use regression analysis to estimate the effect of quality on the propensity to enter foreign markets. A one-standard-deviation increase in quality increases the probability of entry by 25–50 %. Systematic differences in taste for different genre types are used to estimate a measure of cultural distance between countries. Movies in “culturally dependent” genres are less likely to enter foreign markets and their probability of entry is less sensitive to quality. The cultural distance measure enters a gravity equation of US bilateral trade significantly.

Heterogeneous multinational firms and productivity gains from falling FDI barriers

This paper quantitatively assesses the impact of falling foreign direct investment (FDI) barriers on individual firms and its implications for intra-industry reallocation and aggregate productivity. We calibrate the firm-heterogeneity model of Eaton et al. (Econometrica 79(5):1453–1498, 2011) to match micro-level data on Japanese multinational firms facing fixed and variable costs of foreign production. We demonstrate that the calibrated model can be used to replicate the entry and sales patterns of Japanese multinationals. Counterfactual simulations show that declining FDI barriers lead to a disproportionate expansion of foreign production by more efficient firms relative to less efficient firms. A hypothetical 20 % reduction in FDI barriers is found to generate up to a 26.8 % improvement in industry-level productivity through global market-share reallocations within the industry. Compared with fixed entry barriers, reallocation effects and productivity gains are larger for a reduction of variable costs of foreign production.

Corporate financial structure, misallocation and total factor productivity

This paper studies the quantitative relevance of the cross-sectional dispersion of corporate financial structure in explaining the intra-industry allocation efficiency of productive factors. I solve a heterogeneous firms model with financial constraints and distortions to the marginal rental-rate of capital, and develop a measure for the intra-industry misallocation of factors of production. The distribution of capital rental rate and two types of firm-level balance sheet characteristics (pledgeability and liquid asset positions) determine the extent of misallocation and industry level total factor productivity (TFP). I calibrate the model using firm-level balance sheet data from seven major industry clusters of the US economy. The counterfactual policy experiments show that weakening the observed balance sheet positions for financially constrained firms leads to a reallocation of production factors from firms with high cost distortions to firms with low cost distortions and cause quantitatively important industry level TFP losses.

The effect of firm-level productivity on exchange rate pass-through

A heterogeneous-firm trade model can explain the recent decrease in exchange rate pass-through to aggregate US import prices as a result of decreased trade costs. This paper finds support for this explanation by testing another implication of this type of heterogeneous firm model: lower exchange rate pass-through for goods that are traded for short periods of time.

Trade, wages, and profits

This paper formulates a structural empirical model of heterogeneous firms whose workers exhibit fair-wage preferences, leading to a link between a firm's operating profits and wages of workers employed by this firm. We estimate the parameters of the model in a dataset of five European economies. The model predicts an exporter wage premium, which we find to be sizable in all countries, with nearly 6% on average. The estimates enable us to conduct counterfactual exercises. We find that openness to international trade has quantitatively important effects, leading to higher wage inequality and lower aggregate employment.

Do local industrial agglomeration and foreign direct investment to China enhance the productivity of Taiwanese firms?

This article examines the impacts of industrial agglomeration and outward foreign direct investment (OFDI) on the total factor productivity (TFP) of Taiwanese firms. A vertical FDI-based model of heterogeneous firms is proposed to analyze how agglomeration economies and technology incompatibilities between parent firms and their affiliates can affect firm productivity. This model suggests that firms located in areas with more concentrated industrial agglomerations are more productive, while those engaging in OFDI may not perform better in terms of TFP. Using plant-level data, this article constructs an indicator of industrial agglomeration to appraise agglomeration economies on firm productivity. Based on the data for 578 manufacturing firms and the agglomeration indicator, we estimate a cross-sectional econometric model to empirically assess the productivity effects of industrial agglomeration and OFDI. The empirical results show that local industrial agglomerations exert a positive contribution to firm productivity, but that FDI in China has no significant effects on Taiwanese firms' TFP.