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Productivity, Quality and Exporting Behavior Under Minimum Quality Requirements. Juan Carlos Hallak Universidad de San Andres & NBER Jagadeesh Sivadasan University of Michigan. October 2008. What determines firms’ export success?
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Productivity, Quality and Exporting Behavior Under Minimum Quality Requirements Juan Carlos Hallak Universidad de San Andres & NBER Jagadeesh Sivadasan University of Michigan October 2008
What determines firms’ export success? • Most theoretical and empirical work emphasizes a single firm attribute as the determinant of success both in the domestic and in foreign markets • This attribute is often modeled as productivity (e.g. Melitz 2003, Bernard et al. 2003, Chaney 2008, Arkolakis 2008), or alternatively as the ability to produce quality (e.g. Verhoogen 2008, Baldwin and Harrigan 2008, Kugler and Verhoogen 2008) • In either case, the models predict a monotonic relationship between the single attribute (“how good the firm is”), firm size and export status
Predicted percentage of exporting firms, by “ability” Fraction of exporters 1 u Ability
Predicted percentage of exporting firms, by size Fraction of exporters 1 Size
Our aim in this paper • Provide a more nuanced characterization of firms’ export behavior • Explain the existence of small firms that export and large firms that remain domestic • Emphasize the notion that what makes you large and successful in the domestic market might not be that helpful to make you a successful exporter • Identify specific firm attributes (productivity and caliber) that explain domestic versus export success • Inform public policies aimed at fostering export performance and international competitiveness
Our model in a nutshell Assumptions • There are two sources of heterogeneity • Productivity: the ability to produce output using few variable inputs • Caliber: the ability to produce quality paying low fixed costs • There is a minimum quality requirement to export Motivation: • International business: anecdotal and survey evidence of firms’ need to upgrade quality to enter foreign markets • International organizations: concern about quality standards that firms in developing countries find hard to attain • International trade: product quality is associated with firms’ export success (Brooks 2006, Verhoogen 2008) • Other standard assumptions • Fixed entry costs, fixed exporting costs, iceberg transport costs, (quality-augmented) CES demand, monopolistic competition.
Our model in a nutshell (cont’d) Results • Explaining the figures • High productivity/low caliber firms are large but cannot profitably export • low productivity/high caliber firms are small but do export • Predictions • Conditional on size, exporters produce higher quality and charge higher prices. • Assuming that higher quality products require higher quality factor inputs, exporters also pay higher average wages and are more capital intensive
Other multi-attribute models in the literature • Multi-attribute models can explain Figure 1. In addition to productivity, they emphasize: • Heterogeneity in fixed/sunk export costs (Das, Roberts, Tybout 2007, Ruhl 2008) • Heterogeneity in perceived quality between the domestic and export market (Nguyen 2007) • Heterogeneity in export history, i.e. whether sunk export costs have been paid in the past (Das, Roberts, Tybout 2007, Alessandria and Choi 2007, Ruhl 2008) • While these models can explain Figure 1, they cannot account for all the facts we document
Outline of the Presentation • Motivation • The closed economy • The open economy – benchmark case without minimum quality requirements • The open economy with minimum quality requirements • Empirical specification • Empirical results • Robustness checks
The Closed Economy • Demand • where • Marginal cost , • Fixed cost ,
Profit function: • Optimal quality and optimal price: • where
Ability, revenue and profits We can define “ability”as: Revenue and profits can be expressed as increasing functions of => is a sufficient statistic for both revenue and profits: there is a minimum level such that iff
Equilibrium in the closed economy () Domestic firms Non Survivors h(j,())=h (): cut-off between survivors and non survivors Curves here also iso-revenue and iso-profit curves => firms with same revenue and profits have the same survival status
Open Economy with unconstrained export quality • Demand for exporting firm is given by • Fixed cost of exporting: • Define the difference in profits between exporting and not exporting as (it only depends on ) • A firm exports iff
Unconstrained Export Quality Equilibrium u() () Exporters Domestic firms h(j,u())=hu Non Survivors h(j,())=h (): cut-off between survivors and non survivors u(): export cut-off in the unconstrained environment Curves also here are iso-revenue and iso-profit curves => firms with same revenue have the same export and survival status
Unconstrained Export Quality Equilibrium Fraction of exporters 1 u Ability ()
Unconstrained Export Quality Equilibrium Fraction of exporters 1 Size
Constrained Export Quality Equilibrium • Assumption: exporting requires attaining minimum a quality level • Potential sources • Quality standards, typically (but not always) related to countries’ income per capita • Good apples out – higher proportional transportation costs for low quality goods (Alchian-Allen 1964, Hummels and Skiba 2004) • Informational asymmetries in international transactions (Guler et al. 2002, Hudson and Jones 2003, Teerlak and Kind 2006, Claugherty and Grajek 2008)
Constrained Export Quality Equilibrium (): cut-off between survivors and non survivors Region V: Unconstrained exporters u(): export cut-off in the unconstrained regime () Region IV: Constrained exporters x(): export cut-off in the constrained regime x() Region III: Domestic firms (): iso-quality curve for threshold quality Region II: Domestic firms u() Region I: Non-survivors ()
Constrained Export Quality Equilibrium (): cut-off between survivors and non survivors Region V: Unconstrained exporters u(): export cut-off in the unconstrained regime () Region IV: Constrained exporters x(): export cut-off in the constrained regime x() Region III: Domestic firms (): iso-quality curve for threshold quality Region II: Domestic firms u() u() Region I: Non-survivors ()
Iso-Revenue Curves in the Constrained Export Quality Equilibrium rx r3 Region V: Unconstrained exporters (): cut-off between survivors and non survivors u(): export cut-off in the unconstrained regime A () B Region IV: Constrained exporters x(): export cut-off in the constrained regime x() C Region III: Domestic firms (): iso-quality curve for threshold quality Region II: Domestic firms r3 rx u() ru u() Region I: Non-survivors r1 ()
Model predictions for quality, prices and export status • Firms on the same iso-revenue curve do not necessarily have the same export status • Conditional on size, exporters produce higher quality than non-exporters (Proposition 2) • Conditional on size, exporters sell at a higher price (Corollary 1)
Model predictions for average wage, capital intensity and export status • Assuming that product quality requires higher quality factor inputs, we also obtain: • Conditional on size, exporters pay higher average wages (Corollary 2) • Conditional on size, exporters use capital more intensively (Corollary 3)
Empirical Specifications • The theoretical result is • We assume which implies that • Parametric: is an industry-specific cubic function • Semi-parametric: is a set of industry-specific size-decile dummies • Non-parametric: Locally-weighted regression (Cleveland, 1979) 25
Other price robustness checks • Omitted broadly classified products • by excluding products ending with 0 or 9 in US • Excluding products with n.e.c or n.e.s in definition in India • Excluded non-manufacturing products in US data (products not starting with 2 or 3) • Addressed sparse coverage of quantity (hence price) data • Included only product codes with full coverage, and at least 25 observations
Other robustness checks • Measurement error in size variable could induce an upward bias on export dummy variables. Address this in 4 ways: • Use employment as an alternative size control • Condition on “firm size” in US regressions • Use establishment four-year means in Chile/Colombia panel data • Use interactions of industry characteristics (discussed later) 34
Interaction tests • A number of recent alternative multi-attribute models have other sources of heterogeneity that could explain Figure 1, but not all of our findings • Also, we examine variation in exporter premia across industry characteristics: • Degree of product differentiation • Characteristics of export markets
Conclusions • Firm attributes that are critical for domestic success may be relatively less important for success in the export market • In particular, productivity is important for success in the domestic market while caliber relatively more important for success in the export market • Firms that are large in the domestic market (due to high productivity) might not be able to export; conversely, exporters might be relatively small firms • Conditional on size, exporters produce higher quality and sell at a higher price • Conditional on size, they also pay higher average wages and are more capital intensive 38
The cut-off function • Note: • This is a function (curve) as opposed to a point • The cut-off caliber is a negative function of productivity • More productive firms can survive with lower caliber
Some definitions • Fixed cost of entry: • Joint dist. of productivity and caliber: • Probability of survival: • Joint dist. conditional on survival:
The Free Entry Condition • Post-entry expected profits are: • Free entry imposes: • The free entry condition and the cut-off function (or the free entry condition and the zero cut-off profit condition as in Melitz) form a system for which a unique solution exists
Open Economy with unconstrained export quality • Demand for exporting firm is given by • Assume fixed cost of exporting: • Define the difference in profits between exporting and not exporting as (note: it only depends on ) • A firm exports iff , which determines cut-off function:
Characterization of the Unconstrained Export Quality Equilibrium • Results are still isomorphic to Melitz’s (think of ability as the productivity parameter in the Melitz model) • Ability is a sufficient statistic for size (revenue) and export status • Conditional on size, there is no variation in export status, i.e. firms of a given size are all either exporters or non-exporters
Iso-Revenue Curves in the Constrained Export Quality Equilibrium rx Region V.a: Unconstrained exporters r3 (): cut-off between survivors and non survivors Region V.b: Unconstrained exporters u(): export cut-off in the unconstrained regime A () B Region IV: Constrained exporters x(): export cut-off in the constrained regime x() C Region III: Domestic firms (): iso-quality curve for threshold quality Region II: Domestic firms r3 rx u() r2 ru u() Region I: Non-survivors r1 ()
