Export opportunities raise the value of investing in risky innovation projects

Inequality in the size of firms and the wages they pay varies greatly across sectors, it has increased over time and it is higher in industries with more export opportunities. Research by Alessandra Bonfiglioli, Rosario Crinò and Gino Gancia explains these observations using an analytical framework in which firms” investments in R&D affect the dispersion of the potential outcomes for their productivity.

Their study, which is published in the March 2018 issue of the Economic Journal, shows how export opportunities and lower entry costs disproportionately raise profits for more productive firms, thereby encouraging entrepreneurs to invest in riskier innovation projects with higher upside potential.

As a result, globalisation leads to greater technological heterogeneity among firms, which in turn raises inequality in firms” sales and wages. The researchers provide supportive empirical evidence for this analysis from US data.

It is widely recognised that firms differ in size and productivity even within narrowly defined industries, and that firm heterogeneity is important for understanding trade, productivity and wage inequality. Yet, besides some well-known aggregate statistics, there is scant systematic evidence on how firm heterogeneity varies across industries, countries and time, and even scarcer theoretical explanations. This research takes a step towards filling these gaps.

First, the researchers document some little-known facts about how firm heterogeneity in sales varies across industries and time in the US economy. Using establishment-level data, they show that the dispersion of sales varies by a factor of 10 across finely defined industries, and that it has increased on average by 11.8% between 1997 and 2007.

The study then provides evidence that heterogeneity in sales and labour productivity rises as both export intensity and average sales per establishment increase at the industry level. The estimates suggest that the observed increase in export intensity of 21% over the period 1997-2007 explains between 13% and 52% of the increase in sales dispersion.

The researchers then propose a new theoretical explanation for these facts. The main premise is that observed heterogeneity stems from technological choices made when new products are introduced. The theory formalises the idea that firms face a trade-off between investing in smaller innovation projects with less variable outcomes, and more ambitious projects that may generate both big failures and big success.

The analysis yields two main predictions:

• First, export opportunities, by disproportionately raising profits for the most productive firms, which sell in world markets, increase the value of betting on bigger innovation projects with more dispersed outcomes. This, in turn, generates more inequality.

• Second, lower entry costs, by raising competition and making firm survival harder, also encourage firms to choose larger and riskier projects.

These predictions can explain why firms competing in global markets often aim at more ambitious innovation strategies. For example, in 2010, Google started to invest in the ”Google X” project, a semi-secret lab dedicated to making major, high-variance, technological advancements.

The analysis also predicts that when more productive firms pay higher wages, as the data show, trade amplifies wage dispersion by making firms more unequal. Evidence from individual-level US wages over the period 1997-2007 consistently shows that export opportunities increase both firm heterogeneity and wage inequality at the industry level.

Why firms differ so much in sales and productivity is one of the main open questions in the fields of international trade, macroeconomics and economic development. The results in this study suggest that besides reallocating resources across existing firms, export opportunities and competition also increase the value of investing in riskier technologies. This hints at a powerful new channel through which globalisation is making firms and wages more unequal.

”Betting on Exports: Trade and Endogenous Heterogeneity” by Alessandra Bonfiglioli, Rosario Crinò and Gino Gancia is published in the March 2018 issue of the Economic Journal. Alessandra Bonfiglioli is at Universitat Pompeu Fabra and CEPR. Rosario Crinò is at the Catholic University of Milan, CEPR and CESifo. Gino Gancia is at CREI and CEPR.

Gino Gancia