A growing body of economic research documents the potential negative effects of increased trade integration, often with a focus on increased Chinese import penetration. This column argues that some US firms benefit significantly from increased import opportunities as they lower their costs and expand. Protectionism in the form of higher domestic tariffs would decrease these domestic firms' competitiveness both at home and abroad.
Globalisation is under threat. The backlash against it was evident in the Brexit referendum of June 2016, and again in the US presidential race last autumn. A growing body of economic research also documents many potential negative effects of increased trade integration. This work largely focuses on increased Chinese import penetration, and argues that it has harmed US local labour markets (Autor et al. 2013), decreased US employment in import-competing manufacturing industries (Autor et al. 2014, Pierce and Schott 2016a), hampered US innovation (Autor et al. 2016), influenced US politics (Autor et al. 2016, Che et al. 2016), and even increased Americans' mortality rates (Pierce and Schott 2016b). This evidence paints a bleak picture of trade, and may be fuel for the rhetorical fire waged against it in the current political discourse.
Global sourcing opportunities
In a recent paper, we bring a new perspective to this debate by focusing on a potentially positive effect of trade: namely, the opportunity for firms to access cheaper inputs from foreign suppliers (Antras et al. 2016). Distinguishing final good trade from firms' input sourcing decisions is important, since intermediate inputs account for approximately two thirds of international trade (Johnson and Noguera, 2012), and vertical specialisation across countries is an important and growing feature of the world economy (Hummels et al. 2001; Hanson et al. 2005).
China and input sourcing
In line with previous work, we document the impact of changes in imports from China from 1997 to 2007. Using firm-level US Census data on production and imports, we show that US manufacturers that grew their imports from China also grew their domestic sourcing, their sourcing from third markets, and the number of countries from which they import. These results are surprising, since one might have expected imports sourced from China to displace inputs made elsewhere. In contrast, the data suggest that savings from China allow firms to grow sufficiently so that they also use more third-market and domestic inputs. Since domestic inputs require labour to produce, the results imply that importers increase the demand for US workers used in their firm and/or by their suppliers.
We also estimate the causal impact of changes in US manufacturers' Chinese imports on domestic and third-market sourcing. To do so, we exploit the significant productivity growth within China and its accession to the WTO in 2001 to construct a firm-specific, exogenous shock to the potential savings from Chinese imports. In the spirit of Autor et al. (2013) and Hummels et al. (2014), we instrument for changes in US firms' imports from China using changes in Chinese export shares to other high-income countries in a firm's 1997 input industries. To distinguish the role of sourcing from import competition, we also include specifications in which we control for changes in import penetration from China in a firm's output industry, and in which we instrument for changes in import penetration using a shock to Chinese potential in a firm's output industry. Across all specifications, we find that firms that increase their Chinese imports also grow their domestic sourcing, sourcing from third markets, and the number of countries from which they import. In contrast, increased import competition generally has a negative impact on these outcomes.
A framework for analysing global sourcing
Our research provides a theoretical framework that can explain these results, and that can be used to quantify the aggregate implications of an improvement in the potential savings from Chinese imports. In our paper, we present a model with heterogeneous firms that self-select into importing based on their productivity and country-specific variables, such as wages, trade costs, and technology. Firms can, in principle, buy intermediate inputs from any country in the world. However, adding a country to the set of countries from which a firm is able to import requires incurring a market-specific fixed cost.
In this setting, it is difficult to determine the profit-maximising set of countries from which a firm will import. This is because the marginal benefit of adding a particular country depends on the other countries from which the firm imports. Sourcing decisions across countries are therefore interdependent, which affects whether improvements in one country (e.g. China) will lead firms that import from China to increase or decrease their sourcing from other countries.
Despite these complications, we show that, under an empirically relevant condition, selection into importing exhibits complementarities across source markets. More specifically, when demand is responsive to changes in price, or there is large dispersion of input productivities across locations, the addition of a country to a firm's portfolio of input sources necessarily increases the marginal gain from adding other locations. As a result, the model predicts that the number of countries from which a firm imports will be increasing in firm size, a prediction that holds in our US data, as we document in Figure 1.
We use the Census data to estimate the model and confirm that the condition guaranteeing complementarity in firms' sourcing decisions is indeed satisfied in the data. Our estimates also imply that an average US firm sourcing from all 66 foreign countries in our sample faces around 9% lower input costs than a purely domestic firm, and consequently has sales that are approximately 32% larger. A firm at the 90th percentile of foreign sourcing intensity imports 47% of its input purchases, which implies cost savings of 30% and a 176% increase in its sales due to global sourcing.
We also use the model to analyse the implications of a positive ‘shock’ to the potential cost savings from China. In the ‘complements case’, the model predicts that firms that begin importing from a new country (such as China) will also increase their domestic and third-market sourcing. The results from the counterfactual analysis confirm this prediction, and are consistent with the reduced-form evidence on China importers described above. In contrast, non-China importers shrink in response to the shock, since they compete against the importers who now have lower costs.
Fixed costs of sourcing versus marginal cost savings by country
Our quantitative analysis also allows for separate identification of the potential savings of sourcing from a particular country (which depend on technology, trade costs, and wages) and the fixed cost of sourcing from that country (which depend on distance, language, and control of corruption). We estimate that the fixed costs of sourcing in 2007 range from a median of $10,000 to $56,000, are around 13% lower for countries with a common language, and increase in distance with an elasticity of 0.19. As illustrated in Figure 2, our fixed cost estimates are quite heterogeneous across countries in a manner that is largely uncorrelated with the estimated potential savings of these countries. This indicates that countries cannot simply be ranked along one dimension, which implies that only the most productive firms may source from high fixed cost countries, even if they offer the most potential cost savings.
Finally, our framework and estimation shed light on the impact of global sourcing on US consumers and workers. In our model and counterfactual analysis, China's increased savings potential causes the US price index to fall 0.2%, as firms sourcing from China lower their prices. This reflects the fact that cheaper inputs allow some firms to lower their costs, thereby increasing the competitive environment in which all firms operate. This leads importing firms to expand, while the less productive firms that cannot take advantage of the China shock shrink. Figure 3 illustrates these changes. Firms at the top of the distribution grow, while medium and small firms that are not sufficiently productive to import from China shrink or exit altogether. Our framework thus predicts that global sourcing magnifies pre-existing differences in underlying firm productivity and increases the skewness in the size distribution of firms. Although this reallocation will entail displacement for some workers, consumers all enjoy lower prices and aggregate productivity grows.
Implications for trade policy
There is mounting evidence that there are winners and losers from trade. While the theory in our paper is consistent with these findings, our work also points to a big potential cost of addressing these distributional consequences by limiting trade. In particular, it is clear that some US firms benefit significantly from increased import opportunities as they lower their costs and expand. Even if trade partners do not retaliate in response to increased protectionism, higher domestic tariffs would decrease these domestic firms' competitiveness both at home and abroad. This represents a potentially significant drawback of protectionism that should not be ignored in the current debate about the costs and benefits of globalisation.
This article first appeared on www.VoxEU.org on March 12, 2017. Reproduced with permission.