Summer Scholar: Smith Presents New Data on India at U.S. International Trade Commission

Editor’s note: This is part of a series of stories exploring what Gordon professors are up to in between semesters.

Dr. Smith goes to Washington. Again. In early June, Stephen Smith, professor of economics & business, was invited to speak on a panel at the American Enterprise Institute. On July 23, he traveled to the nation’s capital to present new research at the U.S. International Trade Commission. Along with long time collaborator, Michael Anderson, the Sadler Professor of Economics at Washington and Lee University, and their new co-author Jose Signoret of the USITC’s Office of Economics, Smith discussed their findings regarding India’s export sector. Theirs is the first study to examine the behavior of Indian firms, whose behavior should shed light on whether findings based on U.S., European or Chinese firms should be considered universal. Below is the introduction to their paper:

Export Prices of Indian Firms: An Examination of Market and Firm Characteristics

By Stephen Smith, Michael A. Anderson and Jose Signoret

       “How do firms matter in international trade?  This has been the focus of intense interest in the international economics literature for close to two decades, and much has been learned.  Exporting firms are different from non-exporters—they are larger, have higher productivity and capital intensity, and pay more, among many sharp and now empirically well-established contrasts.  A flurry of work in trade theory that explores firm heterogeneity, particularly with respect to productivity differences, has accompanied this empirical work.[1]

         Much of the evidence comes from studies using firm-level data from the United States on trade and output.  One of the most provocative findings in this literature is that the well-known gravity model result that trade volumes decline with distance arises because of distance’s effect on the extensive margin—that is, because many firms drop out of trade at high distances rather than because all firms trade less.  For firms that trade, the average value of trade per product per firm rises with distance (Bernard and Jensen 2007, 122-3).

             To explore this and other surprising findings, more recent empirical work has begun to focus on even more finely-grained analysis that studies firms’ trading behavior at the product and destination level, and on other countries as well as the United States.  Manova and Zhang (2012, hereafter “MZ”), using 2005 Chinese firm and product data at the HS 8-digit level, find that successful exporters earn more revenue in part by charging higher unit prices and by exporting to more destinations than less successful exporters.  Even within narrowly-defined product categories, firms charge higher unit prices to more distant, higher income, and less remote markets.  MZ argue that firms’ product quality is as important as production efficiency in determining these outcomes.   They present evidence that not only do successful exporters produce higher quality goods (with higher quality inputs), but that firms adjust product quality according to characteristics of the destination market.  In particular, they find that the higher unit values associated with higher distance to destination markets and with serving more destinations is due to compositional shifts within narrow product categories towards higher product quality and higher quality inputs. [2]  Harrigan, Ma and Shlykov (2011, hereafter “HMS”), using 2002 U.S. data at the HS 10-digit level, make a similar finding: U.S. firms charge higher prices for products shipped to larger, higher income markets, and to countries more distant than Canada and Mexico, a result they attribute to higher quality.  HMS also find that firms’ ability to raise unit prices is positively affected by their productivity and the skill-intensity of production.  On their face, the results relating to distance and number of markets appear consistent with the hypothesis first advanced by Alchian and Allen (1964), and developed by Hummels and Skiba (2004), that “per unit” transport costs raises relative demand for high quality goods (the “shipping the good apples out” hypothesis).

Our paper contributes to this literature by analyzing the export behavior of Indian firms in the liberalizing policy environment of the early 2000s.[3]  Using a unique dataset that combines detailed data on individual firms with those firms’ product level trade data over the 1999-2003 period, we examine the determinants of export success, measured in terms of exports’ total value and unit prices.  We make several contributions.  First, ours is the first study to examine the links between export success and both destination market characteristics and firm characteristics.  Second, ours is the first study to examine the behavior of Indian firms, whose behavior should shed light on whether findings based on U.S., European or Chinese firms should be considered universal.  Are Indian firms different, perhaps because of the unique features of the trade policy environment in which they lived in the early 2000s?  Finally, and most broadly, this paper contributes to an important empirical literature that should inform national trade policies.  Understanding the causes of firms’ export success is essential for understanding the full extent of the gains to trade, and how best to promote trade in the course of trade liberalization and in the process of economic development.

We find, in brief, both substantial differences and similarities between Indian and U.S. and Chinese exporters.  In distinction to firms exporting in China and the United States, Indian firms do not show a positive association between the number of destination countries and f.o.b. export prices. But there is a strong positive association between Indian firms’ prices and export revenue, distance, GDP and GDP per capita, just as for the U.S. and China.  These latter findings are consistent with Indian firms varying product quality by destination market, as MZ and HMS have argued for the Chinese and U.S. cases.  Finally, we discuss some particularly preliminary evidence based on matching trade and firm-characteristics data, in which we related export prices to proxies for firm productivity.  Results are very sensitive to choice of units for estimating fixed effects and choice of cluster for calculating standard errors.  The next section discusses our data.  Section III presents our results, and the final section concludes.”

[1] See, for instance, Bernard and Jensen (1999) and Bernard et al. (2007) for surveys of empirical work.  The theoretical innovations are typified by Melitz’s (2003) influential work.

[2] MHZ p. 2.  Martin (2009) and Gorg et al. (2010) are further recent examples of firm-product level studies, for France and Portugal, respectively.

[3] See Kotwal et al. (2011) for a survey of Indian economic reform.

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