Productivity, Quality and Exporting Behavior Under Minimum Quality Requirements

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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

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• 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

3
Predicted percentage of exporting firms, by
ability
Fraction of exporters
1
?u
?
Ability
4
Predicted percentage of exporting firms, by size
Fraction of exporters
1
Size
5
Actual percentage of exporting firms, by size
percentile
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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

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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.

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Our model in a nutshell (contd)

• 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

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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

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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

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• The Closed Economy
• Demand
• where
• Marginal cost
  ,
• Fixed cost
  ,

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• Profit function
• Optimal quality and optimal price
• where

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Ability, revenue and profits We can define
abilityas Revenue and profits can be
expressed as increasing functions of gt
is a sufficient statistic for both revenue and
profits there is a minimum level such that
iff
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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 gt firms with same revenue and profits
have the same survival status
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• 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

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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 gt firms with same revenue have the same
export and survival status
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Unconstrained Export Quality Equilibrium
Fraction of exporters
1
?u
?
Ability (?)
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Unconstrained Export Quality Equilibrium
Fraction of exporters
1
Size
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• 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)

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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
??(?)
?
??
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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
??(?)
??
?
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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
??(?)
??
?
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• 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)

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• 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)

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• 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)

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Summary Statistics
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Log price baseline results (India 1998)
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Log price baseline results (US 1997)
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Log price Lowess regression
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Log price robustness checks
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• 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

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Quality proxy ISO 9000 dummy (India 1998)
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Testing corollaries Wage and capital intensity
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• 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)

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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

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Interaction with product differentiation index
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Interaction with destination GDP distance
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• 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

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BACKUP SLIDES
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• 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

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• Some definitions
• Fixed cost of entry
• Joint dist. of productivity and caliber
• Probability of survival
• Joint dist. conditional on survival

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• 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

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• 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

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• Characterization of the Unconstrained Export
  Quality Equilibrium
• Results are still isomorphic to Melitzs (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

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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
??(?)
??
?
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Log price Lowess regression
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Conditioning on employment
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Conditioning on firm revenue US (1997)
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Conditioning on four-year mean Chile and Colombia