Endogenous firm heterogeneity and the dynamics of trade liberalization

https://doi.org/10.1016/j.jinteco.2007.07.001Get rights and content

Abstract

In this paper, we build a dynamic model with endogenous firm-level productivity that involves ex ante identical firms behaving differently in equilibrium. Heterogeneity arises in equilibrium as firms choose different dates to adopt a new technology. We investigate the effects of international trade on technological diffusion and show that trade has a generally positive impact on the equilibrium rate of adoption (and hence on firm-level productivity). In addition, the model can replicate the stylized fact that exporters are larger and more productive than non-exporters. Finally, we show how our model can be used to interpret the emerging empirical evidence on the firm-level productivity effects of CUSFTA.

Introduction

The classic case for free trade is based on the static efficiency gains from lower trade barriers. However, a recent literature has emerged that stresses the dynamic productivity gains from liberalized trade. The most prominent theoretical papers on the link between trade and productivity are Melitz (2003) and Bernard et al. (2003).1 Both of these models take plant-level productivity as given, and emphasize the potential productivity gains from trade-induced reallocation of market share across firms.2 That is, they argue that trade liberalization will tend to reallocate production toward more efficient firms, generating an increase in aggregate industry productivity.

A key motivation for the development of these models is the well-documented heterogeneity that exists within industries, and empirical evidence that reallocation of production is an important source of productivity improvement in response to trade liberalization. However, the empirical evidence also points to a second prominent source of productivity gains in response to trade liberalization — increases in plant-level productivity (e.g., see Pavcnik, 2002, Trefler, 2004, Baggs et al., 2002, Lileeva, 2006). It is this second source of productivity gain that is the subject of this paper. In particular, we develop a dynamic model that treats firm-level productivity as endogenous, with one implication of the framework being that heterogeneous firms operate in the same industry in equilibrium.3 Such a model provides, as a starting point, an industry that is characterized not by a steady-state outcome, but by an evolution that depends on the choices of individual firms. In doing so, this framework offers an analysis that is complementary to the work of Melitz (2003) and Bernard et al. (2003). Specifically, we consider an environment where firms are ex ante identical, yet heterogeneity arises as an equilibrium outcome. Consequently, this framework admits not only reallocation effects but also firm-level productivity effects in response to trade liberalization.

To explain firm heterogeneity we focus on differences in adoption rates of new technologies across firms since this is one of the primary sources of heterogeneity for firms within the same industry. While one might expect profitable innovations in an industry to be adopted instantaneously (or with some small delay given costs of adjustment), the available evidence on technology adoption suggests a logistic diffusion curve with a lengthy diffusion process. Thus, in a study of 21 innovations, Jovanovic and Lach (1997) report an average of 15 years for a new technology to go from 10% usage to 90% usage. Likewise, as stated by Karshenas and Stoneman (1995):

The diffusion of new technology takes time, often a considerable period of time. Whether it be a new consumer technology spreading across households or a new producer (process) technology spreading across firms it would not be unusual for the time period between first use and say 90 percent usage of that technology to take several decades rather than several years.

This lengthy diffusion process leads naturally to persistent productivity differences across firms within an industry. In this paper, we emphasize differences in the rate of technology adoption as the endogenous source of plant-level heterogeneity. The specific question in which we are interested is how exposure to trade affects the speed of technology diffusion in an industry (and thus firm-level productivity). There is a small literature on the effects of trade on technology adoption (see Rodrik, 1992, Miyagiwa and Ohno, 1995), but only in the context of a single import-competing firm.4 Thus, this paper represents the first attempt to evaluate the link between trade and technology diffusion in a dynamic model of intra-industry trade with firm heterogeneity.5

One reason that exogenous productivity models (such as those of Melitz, 2003 and Bernard et al., 2003) have achieved such influence in the trade literature is their ability to match some key aspects of the evidence on the link between exporting and productivity. In particular, numerous studies have found that exporting firms tend to be larger and more productive than non-exporting firms, yet there is no evidence that exporters have higher productivity growth. Thus, it is worth noting that our model of endogenous technology adoption is also capable of replicating these stylized facts. Specifically, at any point during the diffusion process, exporting firms will be, on average, larger and more productive than non-exporting firms; however, the subsequent productivity growth of these exporting firms will not necessarily be higher than that of the non-exporting firms. This is due to the fact that, in our model, firms that choose to export will also choose to adopt new cost-saving innovations earlier in the diffusion process while non-exporters adopt later in the process. Thus, we see our model of endogenous technology adoption as being complementary to the standard models of self-selection.

In addition, since the previous literature takes firm-level productivity as given, it cannot explain the impact of trade on firm productivity. Thus, in the final section of the paper, we present an asymmetric version of the model and show how it can be used to interpret the firm-level productivity effects of CUSFTA that have been documented by Trefler (2004) and Baggs et al. (2002). However, the main goal of the paper is not to provide a universal model that attempts to encompass the myriad empirical facts on the relationship between trade and productivity, but rather to provide a simple model of endogenous firm heterogeneity that is both capable of examining the positive effects of trade on the speed of technology diffusion, and can serve as a framework for future research. The basic conclusion of the paper is that trade tends to increase the rate of technology diffusion, with a reciprocal reduction in trade barriers causing the adoption process to both begin and end earlier. That is, both exporters and non-exporters adopt faster in a more liberal trading environment.

The structure of the paper is as follows. In Section 2, we solve for the open-economy equilibrium, and discuss the effects of trade liberalization on the endogenous speed of technology diffusion. In Section 3, we investigate the extent to which our model matches the empirical evidence on the Canadian/U.S. trade relationship.

Section snippets

Technology adoption in an open economy

In this section we present an open-economy model of technology adoption. To do so we extend a model of endogenous technology adoption (as in Reinganum, 1981, Fudenberg and Tirole, 1985, Götz, 1999) to allow for both international trade and endogenous entry/exit decisions. As in Götz (1999), we consider an industry characterized by monopolistic competition, which enables us to abstract from the question of whether or not firms commit to a date to adopt the superior technology, since in

The productivity effects of the Canada–U.S. Free Trade Agreement

In previous sections, we focused exclusively on a symmetric model; the countries were symmetric, as was trade policy. Given the widespread use of reciprocal trade agreements, the analysis of symmetric changes in trade policy is certainly of interest. However, even in the context of a reciprocal agreement much debate concerns the costs of lowering domestic trade barriers rather than the benefits from increased foreign market access. This bias is evident in empirical studies of trade agreements

Conclusion

The starting point of this paper is the recognition that industries and firms are constantly evolving, and that understanding this evolution is necessary in order to understand the full implications of trade policy. We take a key determinant of this evolution to be the diffusion and adoption of new technology. By its nature, new technology tends to be employed only gradually by firms, generating an important source of heterogeneity among firms in the same industry. By developing a model that

References (31)

  • A. Bernard et al.

    Comparative advantage and heterogeneous firms

    Review of Economic Studies

    (2007)
  • S. Clerides et al.

    Is learning by exporting important? micro-dynamic evidence from Colombia, Mexico, and Morocco

    Quarterly Journal of Economics

    (1998)
  • Ederington, J., McCalman, P., 2006. International trade and industrial dynamics....
  • D. Fudenberg et al.

    Preemption and rent equalization in the adoption of new technology

    Review of Economic Studies

    (1985)
  • G. Götz

    Monopolistic competition and the diffusion of new technology

    Rand Journal of Economics

    (1999)
  • Cited by (58)

    • The effects of import competition on worker health

      2016, Journal of International Economics
    • Green tangible investment strategies and export performance: A firm-level investigation

      2014, Ecological Economics
      Citation Excerpt :

      Recent papers have sought to shed light on the sources of firm heterogeneity, and they have attempted to identify the drivers of different modes of internationalization. These studies show that international firms are more innovative (Atkeson and Burnstein, 2010; Burnstein and Melitz, 2013; Bustos, 2011; Costantini and Melitz, 2008; Ederington and McCalman, 2008), have superior organizational and managerial practices (Bloom and van Reenen, 2007), and benefit from better market access (Lileeva and Trefler, 2010), product diversification (Bernard et al., 2011) or agglomeration economies (Antonietti and Cainelli, 2011a; Rodrìguez-Pose et al., 2013). In this paper, we argue that GTIS are an additional source of firm heterogeneity.

    • Innovation and the trade elasticity

      2014, Journal of Monetary Economics
      Citation Excerpt :

      The difference is that with innovation, firms have increasing returns, while the models with capital usually assume constant returns to scale. Other related papers that derive theoretical mechanisms for the relation between innovation and trade are Yeaple (2005) and Ederington and McCalman (2008). The outline is as follows.

    • Deforestation, foreign demand and export dynamics in Indonesia

      2014, Journal of International Economics
      Citation Excerpt :

      Recent research on export dynamics has emphasized the complementarity between investment and exporting activities. Costantini and Melitz (2008), Ederington and McCalman (2008), Atkeson and Burstein (2009), Lileeva and Trefler (2010) and Aw et al. (2011) highlight this link across firm-level decisions and emphasize the impact it may have on the evolution of firm-level outcomes over time. We follow this literature by examining the relationship between exporting and the investment in mitigating negative outcomes on the natural environment.

    View all citing articles on Scopus

    We would like to thank seminar participants at the University of Georgetown, University of British Columbia, Simon Fraser University, University of Kentucky, Dartmouth College, University of Illinois, Harvard University and the University of California-Santa Cruz for helpful comments. Any remaining errors are our responsibility.

    View full text