By Beverly Lapham, Queen’s University

Researchers and policymakers have long recognized that firms within an industry differ along many dimensions (size, productivity, participation in international markets, etc.). However, firm-level empirical analysis and rigorous theoretical models with firm heterogeneity have only been developed in the last fifteen years or so. Such analyses improve our understanding of how these differences affect firms’ performance in global and domestic markets and their responses to trade liberalization.

Because the empirical methodologies and modelling approaches are relatively complex, the new ideas from this literature regarding how trade policy affects firms, workers, and the broader economy may not be well understood by non-specialists. This is unfortunate because understanding how the models operate and discerning the findings from firm-level data provides a valuable perspective for policy makers considering the impact of trade policies.

In a new research article, I provide an accessible description of how modern trade models work, and present key results and a selective survey of related trade research that incorporates firm heterogeneity. In that paper, and in another paper with co-authors (Ciuriak et al. 2015), I explore the implications of this firm-based approach to trade theory and empirics to provide recommendations for trade policy and negotiations. These recommendations reflect the key novel features of the theory and empirical evidence including the importance of distinguishing between variable, fixed, and sunk costs of trade; the distinction in industry-level adjustments to trade policy between the intensive margin (changes in trade intensities by firms) and the extensive margin (changes in the number of trading firms); the complex two-way links between trade and firm- and industry-level productivity; and the distributional effects within industries of changes in the trading environment.

The primary policy implications that we discuss are summarized below. Governments should:

1. Consider the impacts of their policies on potential (not only existing) traders and trade flows.
2. Reduce the fixed costs that firms face in participating in international markets (for instance by addressing regulatory differences) in addition to lowering variable trade costs.
3. Coordinate traditional trade policies with other policy areas such as productivity, innovation, investment, and industrial policies.
4. Devote increased attention to the distributional impacts of trade policies for both firms and workers, particularly reallocations across firms within industries.
5. Avoid trade policies that simply reward firms for participating in international markets as such policies may have limited effects on trade volumes.

Policy analysts require:

1. Improved access to firm-level data to better quantify the degree of firm heterogeneity within industries.
2. Employee-employer matched data which is able to provide important insights on the distributional impacts of trade policies on the labour market.

References:

Ciuriak, D., B. Lapham, B. Wolfe (with T. Collins-Williams and J.M. Curtis) (2015). “Firms in International Trade: Trade Policy Implications of the New New Trade Theory,” Global Policy, Volume 6, No. 2, 130-140.

Lapham, B. (forthcoming). “International Trade with Firm Heterogeneity: Theoretical Developments and Policy Implications,” in Redesigning Canadian Trade Policies for New Global Realities, The Art of the State Series, Volume VI, Institute for Research on Public Policy.