4. The Dynamics of Firm-Level Adjustment to Trade Liberalization

Abstract

We build a dynamic model of …rm-level adjustment to trade liberalization that jointly incorporates the main salient features highlighted by recent empirical micro-level studies of …rms and trade. Our model captures the joint entry, exit, export, and innovation decisions (subject to sunk costs) of heterogeneous …rms as they adjust to trade liberalization. We characterize this industrial evolution over its entire transition path to a new steady state with lower trade costs-starting from the time that trade liberalization is …rst announced (but not necessarily yet implemented). We rely on numerical methods to solve for these equilibrium paths. In order to more accurately capture the dynamics of …rm adjustments to trade, we model the sunk nature of market entry costs for both the domestic and export market-as well as the per-unit and additional …xed costs of exporting incurred in every period. Firm-level productivity evolves stochastically, and innovation involves a trade-o¤ between its cost and a return in terms of a "better" distribution of future productivity draws. Although the empirical micro-level studies of …rms and export status initially emphasized the selection e¤ects of more productive …rms into export markets, several recent studies have highlighted a separate channel for the e¤ects of trade on productivity operating through …rmlevel improvements in productivity. Our model captures both of these channels for the productivity enhancing e¤ects of trade-and analyzes their interactions over the adjustment path to lower trade costs. In particular, we highlight how the relative timing and magnitude of …rm-level productivity improvements and export market entry decisions are also determined by non-technological factors such as the timing of trade liberalization announcements and the speed of liberalization. Under all these di¤erent trade liberalization scenarios (anticipated versus surprise, gradual versus sudden), we characterize both the distributional e¤ects across …rms as well as their aggregate e¤ects for industrial performance. We …nd that the anticipation of upcoming liberalization, and a more gradual path of liberalization (once implemented) induces …rms to innovate ahead of export market entry. We are grateful to Robert Feenstra, Elhanan Helpman, and Esteban Rossi-Hansberg for helpful discussions and suggestions. We also greatly bene…ted from all the discussions at the book conference where the paper was originally presented.

Financing constraints, firm dynamics, export decisions, and aggregate productivity

“…On the one hand, this empirical fact depends on two features of the Italian industry: i) the presence of a large number of small firms specialised in producing and exporting high quality manufactured goods; ii) the high level of trade integration of North Italy (where are located around 90% of all the Italian manufacturing firms) with Continental indirect channels and they did not invest the sunk cost to establish a proper presence in the foreign markets. 10 In the empirical dataset we detect on average 14% of firms that every period complain about the lack of external finance availability. In the simulated data, for the firms that continue activity, the only financially constrained investment is the export decision.…”

“…It is calibrated in order to match the fraction of financially constrained firms. 10 Among the parameters that we do not directly calibrate, the elasticities  and  are taken from Melitz and Costantini (2007), and   is assumed to be perfectly correlated to  11 -table 1 about here- Table 1 summarizes the calibrated parameters and the matched moments. The parameter values match the chosen moments reasonably well.…”

“…We follow Melitz (2003) and Costantini and Melitz (2007) and consider a model where each firm in an industry produces a variety  of a consumption good. There is a continuum of varieties  ∈ Ω Consumers preferences for the varieties in the industry 2 Other papers that do not focus on financing constraints but are nonetheless related are Campa and Shaver (2001) and Castellani (2002).…”

Trade Liberalization and Firm Dynamics

“…This result suggests that the relative size of entering firms plays an important role in shaping the change in entry and the aggregate transition dynamics in response to a trade liberalization. 21 We now apply this logic to understand the response of entry and aggregate transition dynamics in our full model with productivity dynamics.…”

Innovation and trade with heterogeneous firms

“…Our paper is most closely related to the recent work of Costantini and Melitz (2007), and Atkeson and Burstein (2006) who also examine innova-3 tion and export decisions in a model with heterogeneous firms. 3 Both papers have in common that they start from a situation in which firms already differ in their initial productivity before an innovation opportunity arises (a binary choice in the former, a continuous choice in the latter paper), and then study how productivity differences evolve over time when trade costs fall.…”