Facilitating Export through Trade Intermediaries

Transcription

1 Facilitating Export through Trade Intermediaries Parisa Kamali March 19, 2017 Abstract I provide three new empirical facts that characterize the role of trade intermediaries in the internationalization process of firms, using firm-level data from Vietnam. First, indirect exporting (that is exporting through trade intermediaries) is not as persistent as direct exporting. This means, intermediaries provide a platform for firms to inspect their performance in the foreign markets; these firms, eventually, either become direct exporters or only produce domestically. Second, firms with indirect exporting experience have a higher chance of becoming direct exporters in subsequent years compared to non-exporting firms. Third, direct exporters with indirect exporting experience have higher export intensities compared to their counterparts without indirect exporting experience. To establish whether these dynamics are generated by supply- or demand-side factors, I develop a DSGE model with heterogeneous firms that features learning about demand and shocks to productivity. I estimate the model and report preliminary results. This model provides a suitable platform to study the impacts of different export promotion policies on the number and performance of exporting firms in the short- and long-term, aggregate export volume, and growth of the economy. PhD Candidate, Department of Economics, University of Minnesota. jalal008@umn.edu. 1

2 1 Introduction Paying attention to how goods cross borders is important for designing effective trade policies that aim to increase export participation and export volume. Generally trade economists assume that manufacturing firms and final consumers are effortlessly matched and firms export their goods directly to the destination. However, recently, a number of studies have attempted to go beyond this conventional theory, Akerman (2010), Ahn et al. (2011), and Blum et al. (2009). These papers incorporate a role for export intermediaries in international trade models. In these models, manufacturing firms sell their products domestically to trade intermediaries who ship the goods to the final destination. This export mode, which is called indirect exporting has been often compared to direct exporting. As it is shown in these papers, direct exporting results in higher potential profit and provides greater span of control over the export process for the firm but it is associated with higher costs that need to be financed upfront. For example, the costs of shipping the products, opening an office in the destination country, advertising, and so on. As a result, direct exporting might not be the optimal choice for all firms. On the other hand, firms that export their products indirectly through trade intermediaries incur lower costs and earn less profit. Recent international theories suggest that the most productive firms export directly to the foreign markets, the least productive firms do not export, and a range of moderately productive firms between these two groups choose to export their products indirectly in order to gain access to foreign consumers. These new findings are mostly about the static characteristics of the firms and not much has been said about the dynamics of indirect exporting and its impact on the internationalization process of the firms. In this paper, I utilize 3 firm-level data sets to study the role of trade intermediaries in Vietnam. The data record different characteristics of firms, such as their size, ownership type, location, industry, export volume, export destinations, and exporting mode of firms over time. I document 3 novel findings about the impact of indirect exporting on the performance of firms in subsequent years: 1. Indirect exporting is not as persistent as direct exporting. 2. Recent indirect exporting experience increases the probability of direct exporting in the subsequent periods. 3. New direct exporters with indirect exporting experience have a higher export intensity compared to direct exporters without the experience. The first finding points out that firms use indirect exporting to test their performance in international markets at lower costs. During this experimental state, they might realize that they are better or worse than what they expected at exporting. Thus, indirect exporting provides a self-discovery mechanism for firms. 2

3 Second fact emphasizes that indirect exporting not only provides a platform for firms to test their performance in international markets, but also behaves similar to a steppingstone for firms to learn about factors that assist them to export directly in near future. Firms could potentially learn about demand or supply side factors. Using data on export destinations, I show that the effects of recent indirect exporting experience on the probability of becoming direct exporter vary across markets. This evidence suggests that firms cannot learn only about supply-side factors since those factors impact all markets equally. Therefore, this experience either assists firms to learn about the demand-side (market specific) or demand- and supply-side (market-firm specific) factors simultaneously. I finally show that indirect exporting experience improves the performance of firms conditional on becoming direct exporters. To document this fact, I compare the performance of direct exporters that have indirect exporting experience to their counterparts that were non-exporters prior to exporting directly. I find that firms that have indirect exporting experience tend to have higher export intensities. This means among direct exporter, firms that exported their products indirectly in the past periods tend to export a higher share of their production to the foreign markets, which suggests that these firms are more successful in foreign markets compared to direct exporters that do not have the indirect exporting experience. After I establish my empirical findings, I develop a DSGE model with heterogeneous firms to investigate how much of the dynamics observed in the data are generated by supply versus demand side factors. This model builds on the models of Melitz (2003) and Ahn et al. (2011) and expands them to a dynamic setting in which firms of different productivity and belief (about the appeal of their product in the foreign markets) optimally choose whether to operate domestically, export indirectly, or directly. Moreover, they choose prices of the variety they produce in each market (in face of uncertainty about demand, it matters whether the firm chooses price or quantity. In one the surveys I utilize, owners of enterprises are asked about how they set their prices and more than 75 percent of them respond that they set prices as a fixed markup over their marginal costs). In every period in which the firm chooses to export indirectly or directly, it pays the fixed cost of that specific exporting mode and upon paying the cost it observes the demand in that period. As the firm exports, it learns about the idiosyncratic demand for its product in each foreign market and grows its customer base simultaneously. Firms that learn that their products are not in high demand abroad exit foreign markets and choose to only operate domestically. On the other hand, firms that observe that their products are in high demand remain indirect exporters and continue to grow and eventually become direct exporters. I then estimate the model to match the share of indirect and direct exporters, average export intensity of firms, and the probabilities of remaining in or switching between 3

4 different export modes. 1 Finally, I aim to use my model to evaluate the costs and benefits of government export promotion policies that target direct or indirect exporters. Some of the Vietnamese government s existing programs designate export subsidies to large successful direct exporters. However, I plan to investigate policies that allocate the same amount of subsidies to small firms to finance their cost of entering foreign markets as indirect exporters. I will compare the short- and long-term impacts of existing and alternative policies on Vietnam s export activity. I will assess whether policies targeting small firms increase exports and the number of exporting firms, and thus demonstrate that such policies produce a higher number of stable direct exporters in the long-term. My work is related to different strands of literature. I build on the work of Felbermayr and Jung (2008), Blum et al. (2009), Akerman (2010), and Ahn et al. (2011), who document facts about the characteristics of the firms that export indirectly. This literature studies the static trade-off between exporting directly and indirectly and shows that the most productive firms export their products directly, the least productive firms do not export at all, and moderately productive firms export their products indirectly. I add to this literature by documenting facts about dynamic behavior of indirect exporters and their evolution over time. Crucially, I extend the approach of Ahn et al. (2011) to study the impacts of indirect exporting on the extensive and intensive margins of firm s export decision in subsequent periods. Similar to my work Bai et al. (2017) also study the dynamic decision of firms that decide to export directly or indirectly. However, they focus more on the dynamic tradeoffs between the two export modes and use a structural model to estimate the costs of exporting directly and indirectly. This paper documents new findings regarding the impacts of indirect exporting on the performance of the firm in close future and does not focus on the dynamics of direct exporting since that has been studied in detail before. Moreover, I build a dynamic general equilibrium model that accounts for the empirical findings and provides a proper platform for policy analysis. Inspired by Jovanovic (1982), several papers such as Albornoz et al. (2012), Fernandes and Tang (2012), Timoshenko (2015a,b), Arkolakis (2011), and Fitzgerald et al. (2016) have studied the role of learning about demand in explaining post entry export dynamics. While I use a learning mechanism similar to these papers to generate dynamics in the export decision of firms, I show that learning is not enough for explaining the empirical findings of the paper. However, a model with accumulation of costumer base and learning can both generate the empirical facts and the observed dynamics in the data. This paper is also related to a literature on costumer base. For example, Drozd and Nosal (2012), Foster et al. (2008), and Gourio and Rudanko (2014) have both empirically 1 I am currently working on the calibration of the model. In section 4, I provide preliminary results but I hope to finish estimation and study the policy implications of the model in the next few months. 4

5 and theoretically investigated the post entry costumer accumulation. Finally, in a more general aspect, this paper is connected to the work of Das et al. (2007), Eslava et al. (2015), and Ruhl and Willis (2014) who document findings about the post entry evolution of the firms. This paper follows the idea of Ruhl and Willis (2014) for the gradual increase in the demand which results in a passive increase in costumer base of firms. The paper proceeds as follows. Section 2 describes the data and presents the empirical findings of the paper. Section 3 develops a theory of firm dynamics with heterogeneous firms, two export modes, and learning. Section 4 discusses the quantitative implications of the model by calibrating it to the Vietnamese data and presents the result of the paper. The last section concludes. 2 Data and Empirical Findings In this section, I document new facts about the impacts of indirect exporting on firms future exporting decision and performance. Similar to the definition used in the data, I define goods to be directly exported when they are exported without going through any further sales chain before leaving the country of origin. On the other hand, indirect exporting refers to export of goods, which are sold domestically to a third party agent such as a trade agency or a wholesaler that exports them to the destination country. I use three firm-level panel data sets to investigate the dynamics of export behavior of indirect exporters. While all three data sets are conducted on Vietnamese firms, each contains specific information about the export behavior of firms. I combine the evidence from these data sets to document the following facts: 1. Indirect exporting is not as persistent as direct exporting. 2. Recent indirect exporting experience increases the probability of direct exporting in the subsequent periods. 3. New direct exporters with indirect exporting experience have a higher export intensity compared to direct exporters without the experience. 2.1 Data The first data set I use is the Vietnamese Annual Survey of Enterprises (VES) from 2012 to The data is collected by the General Statistics Office (GSO) of the Ministry of Planning and Investment of Vietnam. This data covers registered firms operating in manufacturing, agriculture, construction, wholesale, retail, and services. The survey is conducted on the second or third quarter of each year and includes firms that were operating on December 31st of the previous year. 5

6 All state owned firms, firms with more than 50 percent of state capital, and firms with foreign capital investment are included in the data set without any size restriction. While all domestic private enterprises with more than 20 employees are interviewed, the ones with less than 20 workers are chosen by random sampling. These firms are divided based on their 4 digit SIC code and 20 percent of each group is sampled. Moreover, household businesses and unregistered enterprises are not covered in this survey. 2 The survey includes information about the identification of the firms, their type of ownership, number of employees, assets, liabilities, capital stock, sales, export and import, the location of the firm, the industry the firm belongs to, tax payments, and etc. I utilize this data set to compute aggregate variables such as the share of exporting firms, the share of indirect exporting to total export (this is equivalent to the total export value of wholesalers and retailers over the total export), and export to sales ratio. The data set also provides a platform for comparison between characteristics of exporters and intermediaries. The downside is that I cannot distinguish the indirect and direct exporters. These values make identifying the extensive and intensive margins of each export mode (that is direct and indirect) trivial. I construct a panel data set and restrict the sample to the firms active in manufacturing and wholesale sector. Table 1 summarizes the sample size, type of ownership of the firms, and share of exporting firms across years. Among manufacturing firms, 76 percent of the firms in the sample are domestic private firms. 16 percent of private domestic firms engage in export across years. 22 percent of the firms in the survey are firms with foreign capital investment. As trade literature has documented before, firms with foreign capital investment tend to export more than firms with domestic capital. In this data set, 69 percent of these firms export to foreign markets. State-owned firms account for 2 percent of the firms in the data and 34 percent of them export. Share of manufacturing firms that export in the sample increases percent, on average, per year, which sheds light on the high growth of export volumes of Vietnam. In the wholesale and retail sector, 96 percent of the firms are domestic private firms, 3 percent are firms with foreign capital, and 1 percent are state-owned. Moreover, only 4 percent of wholesalers export to foreign markets. Table 2 depicts statistics related to the data from VES such as average number of firms per year, some firm specific characteristics, and some characteristics of exporting firms. In manufacturing and wholesale sectors, firms on average have 193 and 23 employees; are 8 and 6 years old; and 22 and 3 percent of them have foreign capital, respectively. Moreover, the overall performance of the manufacturing firms is better than the wholesalers in 2 In 2015, from domestic private firms, all firms with over 100 employees, 50 percent of firms with 50 to 99 employees, 20 percent of firms with 10 to 49 employees, and 10 percent of firms with less than 10 employees in each 4 digit SIC code are covered in the survey. 6

7 Table 1: Number of firms, types of ownership, and share of exporters in manufacturing sector Sample Size Private Foreign Capital Share of Exporters ,969 26,239 5, ,131 20,199 5, ,770 18,780 5, ,237 14,957 6, Notes: Private firms are domestically-owned private enterprises or joint stock companies with less than 50 percent of state capital; foreign capital firms are firms with 100 percent foreign capital or they are joint venture between domestic and foreign owners; and firms are defined to be state-owned if at least 50 percent of their capital is owned by local or central state. foreign markets. Table 2: Summary statistics: Firms and exports, averages Manufacturing Wholesale Mean number of firms per year 25,523 31,528 Mean number of employees Mean age (years) 8 6 Share of firms with foreign capital Share of exporting firms Probability of entry into exporting Probability of exit from exporting Mean export intensity conditional on exporting Mean exporter size (employee) Notes: Statistics are calculated by the author for the cleaned data set of VES. Firms are considered to be exporters if they have positive export values. Export intensity is computed as the total export value over total sales of the firm. Values greater than 1 and less than 1.01 are replaced by 1. Observations with export intensity greater than 1.01 are dropped. The second data set I utilize is the Survey of Small and Medium Scale Manufacturing Enterprises (SMEs) in Vietnam. The survey is conducted by Ministry of Planning and Investment of Vietnam, Ministry of Labor, Invalids, and Social Affairs of Vietnam, and University of Copenhagen biannually from 2005 to This survey focuses on domestically-owned manufacturing firms that do not have state capital and have no more than 300 employees. SMEs play an important role in Vietnam s economy. In 2011, SMEs accounted for 98% of the number of the active businesses, they hired 77% of the workforce, and they produced over 40% of the GDP in Vietnam. The data set consists of questions regarding the identification of the firms, general characteristics, enterprise history, owner/manager characteristics, production characteristics, sales structure and export, costs of raw materials and services, fees, taxes, and informal payments, employment, investments, networks, economic environment, and accounting information of the firms. This data set provides a better representation of SMEs, unregistered, and household enterprises since it only targets smaller firms and covers un- 7

8 registered firms as well. The most important features of the data for this paper are the information about the export mode (that is indirect or direct) and export destination of firms. Table 3 contains total number of firms and number of firms with different types of ownership that participated in the survey in each year. Around 65 percent of the firms in the survey are household-owned and only 1 percent of these firms export. Private firms account for 35 percent of the sample and 16 percent of these firm engage in export. All firms in the survey are domestically-owned and only 0.3 percent of the firms are owned by the state. The total share of exporting firms is between 6 to 7 percent over time. Table 3: Total number of firms, types of ownership, and the share of exporting firms Sample size Private Household State-owned Share of Exporters , , , , , , , , , , , , Table 4 summarizes general statistics about the survey of SMEs. On average, firms have 18 employees and are 18 years old. While only 2 percent of non-exporting SMEs enter foreign markets, 26 percent of them exit and continue their operation as domestic firms. Additionally, 3 and 4 percent of the firms export indirectly and directly, respectively, which suggests 43 percent of the small- and medium-sized exporters export indirectly. Export to sales ratios are lower for SMEs compared to larger firms in Vietnam. This number is 0.35 and 0.37 for indirect and direct exporters, respectively. In line with observations documented in the literature, indirect exporters are smaller than direct exporters in terms of average number of employees. Table 4: Summary statistics: Firms and exports, averages Mean number of firms per year 2,648 Mean number of employees 18 Mean age (years) 14 Share of firms with direct export 0.04 Share of firms with indirect export 0.03 Probability of entry into exporting 0.02 Probability of exit from exporting 0.26 Mean direct export intensity conditional on exporting 0.61 Mean indirect export intensity conditional on exporting 0.51 Mean direct exporter size (employee) 107 Mean indirect exporter size (employee) 47 Notes: Statistics are calculated by the author for the cleaned data set of Vietnamese SMEs. 8

9 In the data, some firms export directly and indirectly simultaneously. This phenomenon might be due to different reasons. For example, firms might export a product to a market indirectly for a part of a year and switch to exporting the same product to the same market directly later during the same year; firms could export the same product to different markets using different export modes; or firms could be exporting different products to the same market directly and indirectly. Since none of the data sets I utilize, specify exports in product level, I am not able to distinguish between these hypotheses. However, in appendix, I show that firms that export both directly and indirectly tend to be larger than direct exporters, have higher export volume, and higher domestic sales. Thus, I believe time aggregation does not play a major role in creating simultaneous indirect and direct exporting. For the rest of the paper, I assume firms that use both export modes are direct exporters. In the appendix, I consider a model with 3 countries in which the cost of exporting to foreign markets is different and a firm might export to one market directly and to the other indirectly. The last data set that this paper utilizes is the World Bank Enterprise Survey. This panel data set is conducted in 2005, 2009, and 2015 and contains sample of firms active in different sectors with various sizes. Data set has information on the characteristics of the firm, general information about the manager/owner, infrastructure of the firm, sales and supplies, degree of competition, crime and unofficial payments, finances, relationship with the government, labor and employment, and the performance of the firm. The major benefit of this data set is that export mode (direct or indirect) of the firms is recorded and the export value for each mode is provided. Moreover, the data set provides a better representation of large firms in the economy compared to the SME data set. However, data is not collected in many rounds and there are large gaps between the years in which the survey is conducted. Table 5 provides a brief description of the data. I keep firms that are only active in the manufacturing and wholesale sectors. Manufacturing firms tend to be larger, older, and more engaged in export activities compared to their counterparts in the wholesale sector. The summary statistics confirm the expected relationship between direct and indirect exporters in terms of size and export to sales ratio. On average, direct exporters are larger and have higher export intensities than indirect exporters. 2.2 Facts on the Persistence of Indirect Exporting For empirical purposes, I divide firms into three disjoint groups. Non-exporters, indirect exporters, and direct exporters. As discussed before, firms that export directly and indirectly in the same year, are classified as direct exporters. I exploit the panel dimension of World Bank data sets by investigating the cross 9

10 Table 5: Summary statistics: Firms and exports, averages of 2005, 2009, and 2015 Manufacturing Wholesale Mean number of firms per year Mean number of employees Mean age (years) Share of firms with direct export Share of firms with indirect export Mean direct export intensity conditional on exporting Mean indirect export intensity conditional on exporting Mean direct exporter size (employee) Mean indirect exporter size (employee) tabulation of firms transition behavior over time. 3 Table 6 suggests that 93 percent of the firms that did not export in t 1, remain non-exporters in period t. Similarly, 93 percent of the firms that engaged in direct exporting in t 1, export directly in t as well. The transition matrix of these two states shows what Baldwin and Krugman (1989) call hysteresis. This means firms that are non-exporters and direct exporters stay in the same state over time with a high probability. However, among firms that exported indirectly in t 1 only 79 percent of them export indirectly in period t. Although this means in short-run majority of indirect exporters might use the same export mode, in the long-run not many firms remain exporting indirectly. 4 Table 6: Cross-tabulation of lag export mode and change in export status. Status in period t Domestic only Indirect export only Direct export Status in Domestic only period t 1 Indirect export only Direct export Share in t Table 7 depicts the long-run behavior of the transition matrix of export modes which illustrates only 14 percent of the firms remain in indirect exporting mode in the longrun independent of their initial state. The share of the firms that remain non-exporters and direct exporters in the long-run is 46 and 40 percent, respectively. This evidence suggests that some firms use indirect exporting as a platform to either test or improve their performance in foreign markets prior to exporting to those markets directly since direct exporting is associated to higher fixed costs that need to incurred ahead of time, 3 Since the SMEs and WB surveys are not conducted annually, I use the transition matrix between t T and t to compute the transition matrix between t 1 and t. This means, I am assuming the transition matrix is the same across the periods. Since the shares of direct and indirect exporters are stable over time, I believe this assumption is not too strong. 4 The cross tabulation matrix and the long-run behavior of firms in the SME survey are presented in appendix A. 10

11 Felbermayr and Jung (2008), Blum et al. (2009), and Bai et al. (2017). Table 7: Long-run behavior of transition matrix Non-exporter Indirect exporter Direct exporter WB Survey For the rest of this section, I further investigate the impacts of indirect exporting on the performance of firms in foreign markets in subsequent years and more generally their internationalization process. 2.3 Facts on the impacts of indirect exporting on the extensive margin of export Table 6 illustrates the dynamics of firms export mode across time. Besides the first finding, this table also suggest that the firms that export indirectly in t 1 are more likely to export directly in period t compared to firms that did not export in t 1. Out of all non-exporting firms, 3 percent of them export their products directly in the upcoming year. However, 10 percent of firms that export their products indirectly become direct exporters in the subsequent period. This means firms that have the experience of indirect exporting have a higher probability of becoming direct exporters compared to the firms without this experience. Firms characteristics such as the age, size, productivity, and type of ownership might impact the export decision of the firms. This means, the impact of indirect exporting experience on the extensive margin of export might be due to characteristics of the firms rather than indirect exporting. Therefore, to account for these firm-level characteristics, I fit the following regression: D j,t = βi j,t 1 + ΓX j,t 1 + γ i + γ l + γ t + ɛ j,t (1) Where D j is an indicator variable that shows if the firm j has exported directly or not in period t. I j,t 1 is an indicator variable that takes the value 1 if the firm j has exported indirectly in period t 1 and it is 0 if the firm did not export in the past period. X is a vector of the characteristics of firm j such as age, total asset, average wage paid by the firm, number of employees, and type of the ownership of the firm. γ i, γ l, and γ y are the industry, geographical location, and year fixed effects, respectively. 5 The results are shown in table 8. Column 1 presents results without controls to show the difference between the probability of exporting directly for firms with and without indirect exporting experience in the last period. In column 2, I control for size and type 5 Since the World Bank survey is conducted in 3 waves with large gaps between the rounds, I use the SME survey data in this section. 11

12 Table 8: Extensive Margin of Direct Exporting (1) (2) (3) (4) Indirect Exporting 0.105*** 0.081*** 0.081*** 0.074*** (0.020) (0.019) (0.019) (0.019) Log(Employment) 0.012*** 0.012*** 0.009** (0.002) (0.002) (0.003) Ownership *** *** *** (0.003) (0.003) (0.004) Age * (0.001) (0.001) Log(Wage) 0.007** (0.002) Year FE No No Yes Yes Industry FE No No No Yes Location FE No No No Yes Observations 10,358 10,358 10,357 8,501 Notes: The dependent variable in each regression is an indicator variable that takes the value 1 if firm is a direct exporter in period t and 0 otherwise. IndirectExporting is an indicator variable that is 1 if firm exported indirectly and 0 if the firm did not export in period t 1. The second column controls for some firm-level characteristics. Ownership is an indicator variable that is 1 if firm is household-owned and 0 if it is a private firm. Third and fourth columns account for both firm-level characteristics and fixed effects. The constant for each regression is not represented. All standard errors are clustered at the firm-level. Significance: 0.05; 0.01; of the ownership of the firms. The impact of indirect exporting experience reduces but remains significant and large. In column 3, I add age of firms and year fixed effects and the coefficient of indirect exporting remains positive and significant. Finally, I add more firm specific measures, industry and location fixed effects and the impact of indirect exporting experience remains positive and significant. These results are suggestive that indirect exporting not only makes it possible for some firms to get access to international markets but it also assists them to get better at exporting and have a higher chance of becoming direct exporters. This experience might impact the performance of firms in different manners. For example indirect exporting can assist firms to become more productive (learning by doing), learn about their demand in foreign markets, accumulate more costumers, and reduce the costs associated to direct exporting. The SME data set provides the destination (country or region) to which direct exporters export their products. This information is useful, since it provides further evidence on the type of the impact that indirect exporting has on the extensive margin of direct exporting. The shortcoming of the data is that the export destinations of indirect exporters are not provided. Thus, I am not able to draw any connections between the set of markets indirect exporters export to and those of direct exporters. However, I can investigate whether the impact of indirect exporting impacts all markets the same or not. 12

13 rately I test the impact of indirect export experience on various export destinations sepa- D j,d,t = βi j,t 1 + ΓX j,t 1 + γ i + γ l + γ t + ɛ j,t Where D j,d,t is an indicator that takes value 1 if firm j has directly exported to market d in period t and 0 otherwise. The rest is the same as equation 1. Then, I compare the impact of indirect export experience on different destinations that the firm directly exports to in the subsequent period. If the indirect export experience assists firms with supply side characteristics 6, then it should have the same impact across different markets. However, I show the indirect export experience matters the most when the firm exports directly to larger markets. For example EU and Japan are large markets that did not have any trade agreement with Vietnam during the time period for which the data is available. Indirect export experience assists firms to enter other large markets that had trade agreements with Vietnam such as US and China as well but the impact is smaller. This experience does not help firms significantly when they export to small markets that are not easily accessible. 7 Table 9: Market Specific Extensive Margin of Direct Exporting China Japan US EU ASEAN Asia Russia Other Ind. Exp * 0.084*** 0.051* 0.101*** 0.049* 0.048* (0.032) (0.030) (0.024) (0.036) (0.024) (0.024) (0.016) (0.015) Obs 6,680 6,680 6,680 6,680 6,680 6,680 6,680 6,680 Notes: The dependent variable in each regression is an indicator variable that takes the value 1 if firm has directly exported to that specific market in period t and 0 otherwise. IndirectExporting is an indicator variable that is 1 if firm exported indirectly and 0 if the firm did not export in period t 1. All regression control for firm-specific characteristics in column 4 of table 8 and year, location, and industry fixed effects. The constant for each regression is not represented. All standard errors are clustered at the firm-level. Significance: 0.05; 0.01; The evidence form table 9 shows that indirect exporting does not affect the probability of becoming direct exporter in all markets equally. While the chance of entry as a direct exporter increases noticeably for markets such as EU, Japan, and China, entry into other markets such as Russia is not significantly affected by indirect exporting experience. This could be the result of intermediaries being more active in some destinations compared to others. However, this evidence suggests that the impact of indirect exporting has a market specific component to it and is not the same across markets. Thus, exporting indirectly cannot only affect the supply side factors such as productivity, financial constraints, and capacity constraints or demand side factors that impact all markets equally such as the 6 Or demand side characteristics which are the same across different markets such as quality 7 Since I do not observe the export destination when firms are exporting indirectly in the data, I am not able to explain whether firms export indirectly mostly to large or small markets, or to markets which are easily accessible or not. Thus, I cannot specify if firms export directly to the same markets that they exported to indirectly or not. 13

14 quality of products. In this paper, I allow for both factors in the model, explain why they are needed to generate the dynamics observed in the data, and estimate the impact of each on the performance of the firm. 2.4 Facts on the Impacts of Indirect Exporting on the Export Intensity In this section, I study the impacts of indirect exporting on the export intensity firms in subsequent years. Table 10 illustrates the cross tabulation of export mode of firms and the mean of the export to sales ratio. The numbers in the table suggest that direct exporters that exported indirectly in the past period have a mean export intensity of 0.60 while the mean export intensity for direct exporters that did not export in period t 1 is only Rest of the numbers in the table suggest that remaining direct exporters tend to have the highest export intensity and indirect exporters that were non-exporters in the prior period have the smallest export to sales ratio. 8 Table 10: Cross-tabulation of lag export mode and mean export intensity Status in period t Indirect export only Direct export Status in Domestic only period t 1 Indirect export only Direct export Next, I control for some firm specific characteristics using the following regression: S j,t = βi j,t 1 + ΓX j,t 1 + γ i + γ l + γ t + ɛ j,t (2) where S j,t is the direct exporting to sales ratio of firm j in time t. Table 11 shows the result of regressions in equation 2. Column 1 contains the raw comparison between the export intensity of direct exporters with and without indirect exporting experience. In column 2, I control for size and type of the ownership of the firms. The impact of indirect exporting experience remains significant and large. In column 3 and 4, I add age of firms, wage they pay, and year, location, and industry fixed effects and the impact of indirect exporting experience does not change. These finding points out that indirect exporting experience not only assists firms to export products directly in upcoming periods but also increases the share of the production that the firm sells in international markets. This phenomenon might take place due 8 Due to data limitation, I cannot distinguish whether the higher export intensity of direct exporters with indirect exporting experience is due to introducing new products (extensive margin) or increasing the export volume of the existing ones (intensive margin). 14

15 Table 11: Export Intensity of Direct Exporters (1) (2) (3) (4) Indirect Exporting 0.118*** 0.112*** 0.112*** 0.112*** (0.032) (0.032) (0.032) (0.033) Log(Employment) 0.003** 0.003** (0.001) (0.001) (0.002) Ownership ** ** * (0.002) (0.002) (0.002) Age (0.001) (0.001) Log(Wage) 0.002* (0.001) Year FE No No Yes Yes Industry FE No No No Yes Location FE No No No Yes Observations 8,043 8,043 8,043 6,661 Notes: The dependent variable in each regression is an export intensity of direct exporters in period t. IndirectExporting is an indicator variable that is 1 if firm exported indirectly and 0 if the firm did not export in period t 1. The second column controls for some firm-level characteristics. Ownership is an indicator variable that is 1 if firm is household-owned and 0 if it is a private firm. Third and fourth columns account for both firm-level characteristics and fixed effects. The constant for each regression is not represented. All standard errors are clustered at the firm-level. Significance: 0.05; 0.01; to changes in either supply or demand side. In appendix A, I investigate whether the export intensity increases equally across different destinations. I conclude that the impacts of indirect exporting in not equal across different markets. Due to data limitation, I am not able to observe the SIC codes of goods that are exported. Therefore, I cannot specify if the increase in the export to sales ratio is due to introducing a new product into foreign markets (extensive margin) or due to increasing the quantity of the existing goods that were exported indirectly before (intensive margin). Fitzgerald et al. (2016) discusses that the product extensive margin accounts for at most 20 to 30 percent of dynamics of revenue at the market level. Therefore, in the theoretical section, I ignore this margin and focus on a model in which each firm only produces one variety. Thus, in the model all the increase in the export to sales ratio will take place in the intensive margin. 3 Model In this section, I discuss the theoretical model I build in detail. This model explains the export decision of firms when different export channels are available, mimics the dynamic behavior of firms entering and exiting foreign markets and switching between export channels, and quantitatively matches the findings described in the previous section. Before introducing the model, I give some intuition about my modeling choices. The main mechanism of this model is the dynamics that are generated by changes in 15

16 the demand side factors. Supply side factors such as financial constraints, productivity, or capacity constraints cannot explain the main findings of the paper since they affect all destination markets equally. In the empirical section, it was shown that the impact of recent indirect export experience on the probability of exporting directly varies across markets. Thus, supply side factors that affect all destination markets similarly such as quality of the products cannot explain the findings either. Since the data does not specify the products that firms export, I ignore the product margin and build a model with single-product firms. 9 I focus on a two country model of monopolistically competitive firms ala Melitz(2003) in which firms have access to two export technologies and do not observe the demand for their products in the foreign market. I assume firms learn about the process of idiosyncratic demand for the variety they produce in the foreign markets while they export it. This learning process generates the dynamics of export behavior and switches between export modes. However, this process does not explain why firms with indirect exporting experience perform have a higher chance of becoming direct exporters in the subsequent periods or why they have a higher export to sales ratio. To capture these findings, I assume firms that export, expand their customer base in the foreign country over time. Time is discrete and is denoted by t. There are two countries; home and foreign. Variables in foreign country are by. Home and foreign country are populated by L and L infinitely-lived identical individuals who work and consume. Countries have masses µ and µ of monopolistically competitive firms that each produces a different variety of final good. 3.1 Household s Problem The representative household in the home country drives utility from consuming a composite final good, C. U = E β t ln(c t ) t=0 ( C t = a t (ω) 1 ω Ω t σ ct (ω) σ 1 σ dω ) σ σ 1 Where Ω t is the total set of available varieties in the home country at time t, a t (ω) is the demand shock for variety ω, c t (ω) is the consumption of variety ω, and σ > 1 is the elasticity of substitution across varieties. 9 Fitzgerald et al. (2016) document that the product extensive margin accounts for at most 20 to 30 percent of dynamics of revenue at the market level and most of the dynamics are generated at the within product level. 16

17 Household provides one unit of inelastic labor to firms, earns wage w t, and faces the following budget constraint: ω Ω t p t (ω)c t (ω)dω = w t l t + π t Where p t is the price of variety ω in time t in the home country, l t is the amount of labor supplied by the household, and π t is the average profit of the firms active in the home country that is distributed among households. Solving consumer s problem, the demand for each variety ω is c t (ω) = (w tl t + π t )a t (ω) p t (ω) σ P 1 σ t Where P t is the aggregate price index and is defined 3.2 Firm s Problem Pt 1 σ = a t (ω)p t (ω) 1 σ dω ω Ω t There is a continuum of monopolistically competitive firms in each country. Upon entry, each firm gets associated to a product variety ω which is globally unique and draws a productivity level Φ to produce the variety ω that can be supplied domestically and internationally. In each period, firms receive idiosyncratic shocks, ζ t, to their productivity. The productivity of the firm follows: φ t = Φ + ζ t where Φ is drawn from a Pareto distribution with a shape parameter χ and ζ is drawn from a normal distribution with mean zero and variance σζ 2. To produce q units of variety ω, a firm with productivity φ t needs to hire l t units of labor such that l t = q t φ t + f i i {D, I, E} Where f i is a fixed cost that firm has to pay before production happens and varies depending on the destination and export technology chosen by the firm. f D, f I, and f E are the fixed cost of producing for domestic market, exporting indirectly, and exporting directly, respectively. All else equal, firms with higher φ t are able to produce at lower costs. Besides productivity, the other component that impacts the profitability of a firm is the demand for the variety that it produces. This component is a market and time specific demand shock, a jt, j {home, foreign}. The demand shock is the sum of a time-invariant variety appeal index θ j and an inter-temporal preference shock ɛ jt. In the 17

18 home country, the demand shock is a t = θ + ɛ t Where the appeal index of each variety is drawn from a normal distribution with mean θ and variance σ 2 ɛ. The inter-temporal shock ɛ t is drawn from a normal distribution with mean zero and variance σ 2 ɛ. The shocks are independently and identically distributed over time. Before entering the foreign market, firms do not know their variety appeal index in that market. As the firm exports, it observes the demand shock, which is the variety appeal index that is subject to an inter-temporal shock. While the firm never observes its appeal index, it learns about it by observing demand shocks through time. At the time of making market participation decision the current demand shock a t is not observable to the firm. Thus, the firm makes foreign market participation decision based on its belief about the appeal index. The prior belief of the firms that have not exported before is given by the distribution from which θ is drawn from. At the beginning of each period, firm decides whether to export to foreign market or not based on its productivity φ t and belief about the appeal index θ. If the firm chooses to export, after paying the fixed cost f i i {I, E}, firm observes the demand shock a t and updates its belief about θ. The posterior belief is given by a normal distribution with mean µ n and variance ν 2 n. The mean and the variance of the distribution from which the belief of each firm in the home country comes from are as follows: and variance µ n = σ2 ɛ θ + nσ 2 θā σ 2 ɛ + nσ 2 θ ν 2 n = σ2 ɛ σ 2 θ σ 2 ɛ + nσ 2 θ where n and ā j are the number and the mean of demand shocks that the firm has observed. Therefore, the belief of the firm regarding its appeal index at time period t after observing n shocks belongs to the following distribution: b N (µ n, ν 2 n + σ 2 ɛ ) In the limit, as n, the posterior distribution converges to a degenerate distribution centered at θ. Firms in the home country face per period fixed cost of producing and exporting directly or indirectly. This cost represents the advertising and marketing cost, marketsearch cost, and etc. Moreover, firms are subject to per unit variable cost, τ i where i {D, I, E} indicates whether the firm is selling domestically, exporting indirectly, or directly. This means τ i units of a variety must be shipped from the home country in order 18

19 for one unit to arrive to the foreign country The Static Decision of the Firm In the face of uncertainty about demand, it matters whether firms choose prices or quantities. In a monopolistic competition setting (with constant elasticity of demand) that firms choose prices, they set it as a fixed markup over the marginal cost. Thus prices only depend on the productivity of the firm. However, when firms choose quantities, prices that clear the market depend not only on productivity but also the belief of the firm about its demand and the actual demand. In the survey of SMEs, owners of the firms are asked about the method in which they set the prices percent of the owners reported that they set prices as a fixed markup over the marginal cost. This number is 74.8 and 72.7 percent for non-exporting and exporting firms, respectively. Thus, I assume, conditional on entry, firms choose prices of the variety in each market. For simplicity, I assume firm observes the appeal index of its variety in the domestic market. Therefore, the firm simply chooses prices to maximize the profit in the home country. Conditional on deciding to operate domestically, firm solves the following problem: π Dt (φ t ) = max p (q Dt (φ t ) ) Dt(φ t )q Dt (φ t ) w t + f D p Dt (φ t) φ t s.t. q Dt (φ t ) = (w tl + π t )a t p Dt (φ t ) 1 ρ 1 ρ P 1 ρ Firms do not observe the appeal index of their product in the foreign market prior to exporting. Conditional on entry into the foreign market using a specific export technology, firms choose prices to maximize the expected profit given posterior belief about the appeal index. Direct exporters of the home country entail per period fixed cost f E and per unit iceberg cost τ E. Firms that export directly solve the following profit maximization problem: Eπ Et (φ t, ā, n) = max E[ (τ E q Et (φ t ) )] p Et (φ t )q Et (φ t ) w t + f E p Et (φ t) φ t s.t. qet(φ t ) = (w t l + πt )a t p Et (φ t ) 1 1 ρ P ρ 1 ρ t Firms do not observe a t and thus they do not know the demand for their variety, q Et (φ t). Solving the problem of a firm conditional on the decision to export directly, the optimal price of exporting is p Et (φ t ) = τ Ew t ρφ t This indicates that prices depend on the productivity of the firm, wage rates, elasticity of substitution between varieties, and the variable cost of exporting. Therefore, prices are not affected by the belief of the firm about the demand for its variety in the foreign 19

20 market. Since prices do not have an impact on how much firm learns about the demand, price choice is a static decision. Prices are not affected by the belief of the firm about the appeal index of its variety and firm sets prices to a fixed markup over the marginal cost of production. Firms that choose to export indirectly, sell their variety domestically to an intermediary that exports them. Similar to direct exporting, firms do not know the appeal index of their variety in the foreign market prior to exporting. Eπ It (φ t, ā, n) = max E[ τ E p It (φ t )q It (φ t ) w t ( τ Eq It (φ t ) + f I ) ] p It (φ t) φ t s.t. qit(φ t ) = (w t l + πt )a t p It (φ t ) 1 1 ρ P ρ 1 ρ t Since varieties are carried to the foreign country by export intermediaries, iceberg costs, τ E, are incurred by them. f I is the per period fixed cost of exporting indirectly which includes costs such as cost of searching for trade intermediaries,... The optimal price for a variety produced by a firm of productivity φ t that chooses to export indirectly is p It (φ t ) = w t ρφ t Prices indicate that firm does not discriminate between domestic consumers and export intermediaries. Prices observed by consumers in the foreign country, however, include the variable cost of indirect exporting, τ I p It (φ t ). This variable cost contains the iceberg cost and an additional per unit cost of relabeling, repackaging, and assembling that is incurred by the intermediary The Dynamic Decision of the Firm The total value of a firm in the home country is denoted by V t (φ t, ā, n). The total value consists of the value of the firm in the domestic market, V Dt (φ t ), and the value of the firm in the foreign market, V F t (φ t, ā, n). All firms in home country enter period t with the knowledge of their productivity φ t. They must decide whether to produce for domestic markets given φ t or exit. Firms that produce receive profit π Dt (φ t ) and an expected continuation value of producing domestically β(1 δ)e ζ V Dt+1 (φ t+1), where δ is an exogenous probability of a shock that forces the firm to exit. The value of exiting is normalized to zero. V Dt (φ t ) = max { π Dt (φ t ) + β(1 δ)e ζ V Dt+1 (φ t+1), 0 } Moreover, in period t firms have knowledge of mean and the number of previously observed demand shocks ā and n, respectively (These values for a firm that has not 20