{"id":291696,"date":"2015-06-06T13:22:12","date_gmt":"2015-06-06T17:22:12","guid":{"rendered":"https:\/\/policyoptions.irpp.org\/2015\/06\/how-trade-changes-when-firms-matter\/"},"modified":"2025-08-28T15:19:45","modified_gmt":"2025-08-28T19:19:45","slug":"how-trade-changes-when-firms-matter","status":"publish","type":"post","link":"https:\/\/policyoptions.irpp.org\/fr\/2015\/06\/how-trade-changes-when-firms-matter\/","title":{"rendered":"How trade changes when firms matter"},"content":{"rendered":"

Businesses, like people, differ in many important ways. Some are quite productive; some aren’t. Some businesses thrive after trade liberalization, while others fail.<\/p>\n

These ideas are almost self-evident, but it turns out that rigorously analyzing them is no easy task. In fact, significant research progress has only occurred in the past two decades by developing new firm-level data sets and trade models (as opposed to the earlier industry or country-level approaches).<\/p>\n

Because this research occurs largely at the academic frontiers and uses complex economic models, the results are not that clear to non-specialists. Thus, the goal of this new chapter in the IRPP’s trade volume<\/a> by Beverly Lapham (economics professor at Queen’s University) is to demystify this research: to provide an accessible overview of recent developments in theoretical trade models and explore some of their policy implications.<\/p>\n

Melitz model<\/strong>
\nLapham describes \u2013in detail, but without the math\u2013\u00a0an important break-through model developed by Marc Melitz that emphasizes firm-level decisions and differences, which was published in 2003.<\/p>\n

This model emphasizes the fixed costs of entering foreign markets, and the fact that entry requires an up-front and uncertain investment. It allows us to conveniently group firms based on their productivity and whether they export.<\/p>\n

\"Lapham_Melitz_sorting\"<\/a>*cpo= cut-off productivity for operating; cpe= cut-off productivity for exporting. Source: Lapham (IRPP, 2015).<\/h6>\n

The model predicts that as a group, exporters will tend to be larger and more productive than non-exporters\u2013\u00a0a result that’s been found for Canada and several other countries. (This chapter<\/a> by Baldwin and Yan reviews the firm-level Canadian evidence and is a nice companion paper).<\/p>\n

Intuitively, only the more productive firms are profitable enough to cover the costs of entering the foreign market. So in the simplest Melitz framework there is “self-selection” into trade, where only “better” firms choose to export. However, it is increasingly clear that the effects go in both directions and that the act of trading can also raise firm-level productivity.<\/p>\n

Of course, the idea that increased trade raises productivity isn’t new. What’s new is the channel that arises for this to occur\u2013through differing responses to trade policy that shift the economy’s resources from firms with lower productivity to those with higher productivity.<\/p>\n

\"Lapham_Melitz_trade_lib\"<\/a>*cpo= cut-off productivity for operating; cpe= cut-off productivity for exporting. Source: Lapham (IRPP, 2015).<\/h6>\n

After trade liberalization, reallocation occurs through entry and exit, which academics often call the “extensive margin”. For example, tariff cuts induce tougher foreign competition (and higher domestic wages), which causes the least productive firms to exit the market. Conversely, improved market access abroad encourages the most-productive firms (of those that previously only served the domestic market) to enter export markets.<\/p>\n

Recent extensions<\/strong>
\nLapham also examines some of the most important recent extensions in this literature. These include:<\/p>\n