5: Heterogenous (Melitz: Gains From Overall Industry Prod Rise Following Trade Liberalisation) Flashcards
So far we assume in trade models firms are symmetric
What do we mean by this
It doesnt matter which precise firms leave and survive the market following trade policy. (Since all homogenous)
In reality firms are heterogenous!
Thus firm heterogeneity means winners and losers within same industry!
We’ll see how most efficient producers survive (if c<c*)
Stylized facts about exporting (2)
Exporting is extremely rare (Only 18% of US firms export in 2002)
Exporting firms are different
Why are exporters different (5)
Larger (double the size of firms that don’t export)
More productive (TFP)
Use factors differently (more skilled and more capital per labour, produce higher quality and innovate)
Pay higher wages
Pollute less
Worst performing firms vs best performing firms response to trade
B) as a result what is the effect on overall industry performance
Worst-performing are forced to exit
Best-performing get new sales opportunities from trade and expand the most
B) it improves
Note: trade and economic integration is said to improve overall industry performance as much as discovering a new technology!
Firm heterogeneity 2 diagrams pg17
Key thing: heterogeneity means different MCs.
Draw MC2 higher than MC1.
Firm 1 lower MC, sells at a lower price BUT has a higher markup over MC (more profit)
Diagram 2:
y axis operating profit
x axis marginal cost
downward sloping line shows as MC increases, operating profit falls
important: cut off point is c, any firm with c>c shuts down as not profitable
Now under economic integration, diagrams pg 20
Diag 1:
Demand curve is now lower intercept and flatter. (More elastic since new firms/market size increases)
Diag 2; steeper and higher intercept to show pore profit can be made for winners, but also which gets a lower cut of point c*’ (where firms will exit). draw on winners losers and exit
Imp: Overall does economy gain from trade and why (2)
b) key result from this
Yes
more varieties from higher n
Higher productivity and lower prices (surviving firms have lowest MC)
b) Trade increase industry productivity!
result comes from selection! expels inefficent firms (losers) and most productive lowest MC firms win
Free trade does not fully exist, trade costs exist like shipping.
2 types of trade costs (Melitz)
iceberg - in order to sell 1 unit abroad, firms must ship t>1 units
fixed exporting costs e.g regulation costs
these trade costs reduce no of firms that sell across borders
what is this known as
extensive margin of trade
trade costs also reduce volume of export sales of firms selling abroad
intensive margin of trade
(so extensive margin is amount of firms selling abroad, intensive is the actual volume of exports)
so trade costs explain why only some firms export, and the ones that do are larger and more productive (lower MCs) thus can firm these iceberg and fixed costs
Add trade costs (t) to the model
Firms response
b) 2 diagrams (home and foreign market)
Pg 24
MC increases, so firms set differnet prices in export market relative to domestic prices
b) diag 1 is just normal MC’s with no trade costs
diag 2: both firms MC (C₁ AND C₂) increase to C₁+t and C₂+t
draw C2+t above the demand curve - whichs they dont choose to export now. So only firm 1 (with the intial lower MC - more productive) exports
Operating profit diagam BEFORE LIBERALISATION pg 26
at c* all firms (non-exporting firms also) must exit
at c* - t: can’t export
operating profit for domestic market is higher than operating profit for export market
Operating profit after trade liberalisation
b) on the diagram pg 27
trade costs fall so cut off for exporting (c*-t) increase.
however cut of cost for domestic market falls, since liberalisation opens cheaper foreign competition
b) shift down in operating profit for domestic
shift up in operating profit for foreign
Imp: so 2 key findings of melitz model
b) key finding - where is gains of trade from
Only productive firms survive (firms with c>c* and c+t>c* must leave), and most productive export (where c+t<c*)
following trade openness, small firms forced to exit (since opens up to foreign cheaper competition)
b) OVERALL industry productivity increases - new source of gains from trade
Standard trade theories identify best factor owners e.g HO predicts the owners of the abundant factor benefit the most
Melitz shows winner and loser firms within the same industry! The firm heterogeneity!
Pavcnik on link between trade and aggregate productivity
found 2/3s of Chile’s 19% increase in agg productivity was due to survival and growth of high-productivity plants
Supports the idea that gains from trade - being higher agg productivity from trade
Criticism as to whether trad liberalisation is really cause of productivity growth
why?
In developing countries, trade liberalisation is used alongside other reforms
so hard to attribute prod growth solely to trade liberalisation
So how does Melitz contrast old theories e.g Ricardo
It says gains arise from WITHIN industries (heterogeneity between firms means productive remain which creates gains)
Not BETWEEN industries (like Ricardo, where gains are made by specialising in industries you have a CA in)
2 hypothesis on productivity premium seen with exporting firms: why are they more productive
self selection - high producitivity induces firms to export
learning-by-exporting - firms that export learner from foreign markets, causing productivity growth
Self selection hypothesis: valid?
Criticism over causal relationship between productivity inducing exporting; data shows exporters can be small, suggesting productivity is not the sole inducer of firms exporting
Learning-by-exporting hypothesis
Firms learn from foreign markets - gain better access to tech, techniques, ideas etc.
Empirical evidence on selection vs learning hypothesis
(Compare earlier evidence to now)
Earlier evidence showed productivity growth of exporters is not signficantly different from non-exporters (thus dismisses self selection hypothesis)
Now, evidence does support self selection, and more evidence of learning-by-exporting in recent years
So importing firms and exports firms have similarities.
Explanation
International production sharing - stages of production are spread across countries.
Explains why productive following trade liberalisation since improves access to cheaper and high quality imported inputs to increase productivity
