Granularity and International Trade

A large literature has developed over the last twenty years or so to understand the role of firm heterogeneity in a country’s exporting behavior.  A key feature of the models in this literature is that they typically assume each firm has measure zero in its industry.  This assumption is useful because it removes strategic interaction between firms and so helps makes tractable the complexities of firm heterogeneity.  An implication of this assumption is that no single firm can affect industry aggregates.  And so the productivity realizations of a single firm or small group of firms cannot affect a country’s aggregate exports.

New research argues that useful insights are gained by relaxing the measure zero assumption, allowing individual firms to be at the center of the analysis.  The reason is that in reality firms, especially the largest ones, can play a pivotal role in business cycle and aggregate trade fluctuations; aggregate welfare; or even on a country’s comparative advantage.  When firms are allowed to be “granular” or large relative to the markets in which they operate, idiosyncratic shocks to individual (large) firms, such as reductions in trade costs and productivity changes across countries, will not average out, and instead lead to movements in the aggregates.  This has already been shown empirically for French and American data.

This new line of research may be particularly useful in studying international trade and economic development.  In developing countries, there is a greater prevalence of industrial policy that promotes exporting by particular firms within sectors.  At the same time, regulatory regimes are often opaque and unpredictable, and credit markets or commercial policies favor large firms.  In this setting, granularity in firms may help to explain why developing economies tend to be fundamentally more volatile than developed economies.   However, there is currently little empirical evidence on the role of individual firms and firm-to-firm linkages in aggregate fluctuations in developing countries.

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