Heterogeneous firms and trade costs: a reading of French access to European agrofood

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1 Heterogeneous firms and trade costs: a reading of Frenc access to European agrofood markets Cevassus-Lozza E., Latouce K. INRA, UR 34, F Nantes, France Abstract Tis article offers a new reading of intra-european trade based on recent developments in new international economics (Melitz, 2003; Caney, 2008). Tese models take te eterogeneity of firms into account and offer a micro-economic analysis of te process of selection at work for firms entering markets. An exporting firm as to bear certain specific costs to break into a market, and only sufficiently productive firms are able to do so. Using individual data for Frenc agro-food firms and te distribution of teir exports across European markets, tis article sows tat access conditions to te various European markets are not identical for Frenc firms: te Belgian market would seem to be a natural extension of te Frenc market, wereas te markets of small, distant countries (Austria, Finland or Sweden) are te least accessible. Econometric analysis based on analysis bot of te firm selection process and of te value of teir exports sows tat te standard geograpical variables (distance, country size) affecting te single European market still play a maor role in te coice of export markets. Results also reveal tat tere are still remaining trade costs at entry to te different European markets; but tese trade frictions don t matter to all firms in te same way. Te iger te firm experience, te lower te impact of trade costs. Keywords firm eterogeneity, trade costs, European Integration. I. INTRODUCTION Te aim of te implementation of te Single European Market in 993 was te free, unimpeded circulation of goods between European countries. Tis implementation was based on te abolition of all tecnical barriers to trade, implying armonisation of food regulations. Beyond te positive impact of tis armonisation as igligted by Henry de Fraan and Vancauteren [] or Cevassus-Lozza et al [2], Head and Mayer [3] sowed tat trade barriers, in 2000, still exist between European (EU) countries, resulting in te persistence of a certain level of market fragmentation. Is tis fragmentation still a reality for Frenc agro-food exporters? Do Frenc firms enoy te same access conditions to all European countries? And if differences do exist, are tese due to structural trade conditions (market size, linguistic barriers and distance) or do tey arise from trade costs wic would suggest tat te European market is still fragmented? Tere is an abundant literature dealing wit trade costs and teir components. Anderson and Van Wincoop [4] define te latter as all costs incurred in getting a good to a final consumer oter tan te production of te good itself. Tey correspond to a variety of costs ranging from trade related policies (tariffs, non tariff measures suc as standards, excange rates...), to transport and logistics, information and marketing and also cultural barriers. Numerous empirical papers, often based on a gravity equation, attempt to assess, at a macro or sectoral level, te impact of tese trade costs on bilateral trade between countries. Most of tem focus on specific trade barriers; but some oters, using te now well known "Border Effect" metodology ([5] or [6]) attempt to capture a global image of all impediments to trade related to te existence of te national borders. Even toug tese studies give a useful measure of tese trade impediments, tey are based on te ypotesis of a representative firm, and do not explain ow tese trade costs affect te excange flows. At a micro-level, te growing empirical and teoretical literature gives an insigt on tis issue. Several empirical studies ([7], [8]) ave first sown tat only more productive firms export. Melitz [9] provided a general equilibrium model sowing tat firms self-select into export markets. Caney [0] goes furter and analyses te access conditions to different export markets. A market wit ig entry barriers will be very selective, and only te best performing firms will be able to break into it by selling greater quantities of teir product (intensive margins). Inversely, a more open market will be accessible to a larger number of less productive firms exporting smaller quantities (extensive margins). However, watever te level of observation, trade costs are unobserved.

2 2 Referring to Caney's model, te aim of tis article is to assess, from individual firm data, a global image of te trade impediments occurring at entry to te different European markets. Our obective is to analyse te access Frenc firms ave on te EU markets. We assume tat te eterogeneity of entry costs between markets is revealed by te firms caracteristics exporting to tese markets. Moreover, numerous studies ( [], [2] ) ave pointed out te key role of experience in te firm decision. Using a survey on UK firms, Kneller and Pisu [3] (2007) identify wat are te most common barriers to export firms report to face. Tey sow tat export experience may cange significantly te barriers to exporting perceived by firms. Following tis statement, we evaluate in tis paper to wat extent trade barriers at entry of European markets matter to all firms in te same way. Te remainder of te paper is structured as follows: section 2 presents te contributions of recent models in new international economics, particularly te model of Caney [0]. Tis model leads onto an empirical section focusing on te number of firms exporting to a destination market. By tis analysis an interpretation of te accessibility of EU markets is put forward. Finally, two sets of econometric estimations are proposed : te first one estimates te value of firms' exports, taking into account te selection at work at entry to different EU markets. Te aim is to test te extent to wic EU market access eterogeneity is only due to market geograpy, or instead attributable to oter specific costs for eac importer, tus potentially revealing tat te EU market integration is incomplete. Te second one takes into account te export experience of te firms. II. TRADE COSTS AND FIRM HETEROGENEIT : CHANE s MODEL A. Te main ypoteses Te consumer utility of disposing of a set Ω of products (determined in equilibrium) and of consuming q o units of good O (single omogeneous good) and q (ω) units of variety ω of sector (H+ sectors wit H sectors producing a continuum of differentiated goods) may be expressed: U q σ µ H σ σ µ o o ( ( ω) ) σ ω q d Ω = wit σ te elasticity of substitution between te two varieties of good and µ is te preference coefficient of te subacent Cobb-Douglas function, between te omogenous good and te differentiated goods. All countries ave access to te same tecnology. Countries differ by size (L n ) and productivity (w n ). To deliver products to country, firms from country i face various trade barriers generating fixed or variable costs. Fixed costs (f i ) may be all te costs due to product compliance (label, packaging ) but also induced by te new distribution networks to invest, te marketing/advertising strategy Variable costs (τ i ) depend on te excanged quantity of product and are included in te model as iceberg-type costs. Firms work using tecnology wit increasing returns to scale due to te fixed costs. Eac firm as a labour productivity ϕ. Te cost of producing and of selling q i units of good to market for a firm wit productivity ϕ is: i i c i( = wτ qi+ fi () ϕ Te random variable Φ wic represents firm productivity ϕ follows a Pareto distribution on [,+ [ wit distribution function written as: P ( Φ< = ϕ were is inverse to eterogeneity measure. Given tat demand is isoelastic, te optimal price fixed by a firm wit productivity ϕ in country is a constant mark-up over te unit cost: σ iτ i pi( = w (2) σ ϕ Tus, given () and (2), te export value from i to, by a firm of productivity ϕ is : σ pi( x i= pi( qi( = µ (3) P B. Definition of te firm s self-select export process Te productivity tresold. Te firms able to export to are tose wic are able to bear te market entry costs. A firm will export only if profit exceeds 0. Te productivity tresold ( ϕ ) is terefore defined for nil profit condition. Tus given (), (2) and (3), ϕ i is : fi σ wiτ i ϕi = λ wit λ P being a constant. Caney sows tat te price index P depends upon te caracteristics of te importing country and is a function of te distribution law for firms entering tis market. Hence, e obtains te following expression of te productivity tresold. i

3 3 wiτ i σ ϕi = λ2 fi (4) θ were is te world revenue and θ is a variant of te trade remoteness of Anderson and van Wincoop [4]. θ N = σ k= ( ) ( k / )( wkτ k ) fk were k represent all te potential trading partners of Te value of exports. Tus, te export value depends upon te above select σ process : ( / > ) = θ x ϕ ϕ ϕ λ i i σ 3 ϕ (5) wiτ i wit λ 3 being a constant. III. PRODUCTIVIT THRESHOLD AND ACCESS TO THE DIFFERENT EU MARKETS : SOME STLISED FACTS. On te basis of te above equations, wat picture emerges of te European market? Te problem resides in measuring costs faced by firms entering a market. Neverteless, it is possible using te selection equation to catc te degree of accessibility of te various European markets for Frenc firms. According to equation (4), te eterogeneous entry costs generate an inverse relationsip between te productivity tresold for exporting to tis market and te number of exporting firms to a market. In fact, te number of firms able to break into a market is te set of firms N i wit productivity ϕ were Ni ϕ > ϕi. Tus, Ni= Ni P( Φ> ϕi) = ( ϕi ) were Ni Ni is te total number of exporting firms of country i. To validate tis relationsip, we ave used data for individual Frenc firms from two sources: - Te register of Frenc Customs (2004), wic identifies, for eac exporting firm located in France, te destination of its exports per product, by value and quantity. - Te file of te annual surveys of enterprises (INSEE: 2004), wic provides individual information about te firms wit more tan 20 employees (main activity, location, turnover, number of employees, level of productivity calculated as value added per employee). Figure validates tis inverse relationsip between te percentage of firms and te minimum productivity level of firms exporting to a country. Markets wit te igest productivity tresolds are tose wit te smallest number of exporting firms. Tere are four groups of countries for Frenc firms: - Unsurprisingly, Belgium is te most accessible market. 82 % of Frenc exporting agrofood firms export to Belgium and te productivity tresold is te lowest. - Germany, Spain, Great Britain, te Neterlands and Italy ave very similar productivity tresolds - Te two oter groups gater te smallest and/or most distant countries including new member states. For te latter exporting firms need to be te most productive in order to access to tese markets. % of Frenc firms e xporting to te country BE DE ESGB IT NL DK GR PT ATIE SE PL HU LT MT SK FI CZ C EE Productivity tresold - first quartile (tousands euros) Fig. Number of Frenc firms per EU markets and productivity tresold. Tese results give an overview of te differences in European market accessibility for Frenc exporting firms. However, tis market ierarcy seems to reflect bot te EU geograpy for Frenc firms and te EU istory. Can we conclude ten tat te EU market is still fragmented? IV. ECONOMETRIC RESULTS: THE GLOBAL IMAGE OF TRADE COSTS FOR FRENCH EXPORTERS. A. Does only geograpy matter for Frenc exporters to European markets? Equations 4 and 5 give te two main steps of te exporting process : first, te decision of te firm i to export towards te market and second, te traded volume. In order to take te self-select process into account, we implemented an Heckman procedure defined as follows : Contrary to oter autors ([7], [4],[5]) wo analyse te decisions of firms to export or not, we ave taken tis decision as exogenous. We only analyse te trade pattern of exporting firms. SI LV

4 4 [ x( ϕ i/ ϕ )] ln [regression of te exported value ] for i ϕ i> ϕ ln i lnϕ > 0 ϕ [selected equation ] Explicative variables come from te structural equations 4 and 5. is te sare of in total EU imports of subsector (Comext database). ϕ i is te firm productivity calculated using te INSEE-EAE database as te ratio value added / number of employees of te firm. τ i and f i catc te variable and fixed costs. Except transport costs wic are approximated by te distance, trade costs are in fact unobserved. Distance d i is calculated from te place of te firm s ead office to te capital of country. Te location of te firm is extracted from te annual survey of firms (INSEE) and te distances ave been downloaded from te Micelin database. To catc te global image of all oter trade costs at entry of market, importing country fixed effects are including in our estimation. θ, te trade remoteness is approximated by N θ = / / dk, were k are te total exports of ( k )( ) k= country k, and are te world exports of sub sector (COMTRADE). d k is te distance between te capitals of te two countries k and given by te CEPII. Finally, 9 sub-sector fixed effects are introduced to take sectoral specificities into account. Tis estimation aims at testing te significance of te importing country dummies coefficients in te two steps (value and select equation). In te event tat tese two sets of coefficients vary greatly from zero, and vary amongst temselves, a eterogeneity of costs on entry to European markets can be concluded, once geograpical factors ave been accounted for. Te econometric results (Table ) sow te expected effects of firm productivity, importing country size and distance. Tus, te greater te firm's productivity, te greater its exporting probability and te iger te value exported. Equally, te larger te importing country, te greater te probability tat Frenc firms export tere and te iger te value of teir sales. Distance as a significant impact bot on te firm's decision to export to a given market and on its exported volume. θ as eiter a non significant impact in te volume equation or a significant negative impact in te probit equation. Furtermore, te results sow tat importing country fixed effects, independent of size and distance, differ widely witin te European market. Tis seems to indicate tat specificities linked to eac European country continue to exist, despite te implementation of te Single Market. Te coefficients for tese country fixed effects follow te market ierarcy observed in Figure. Tus, once country size and distance from France is taken into account, Frenc exporters appear to experience te most difficulty in accessing te New Member States Market and especially Slovak Republic and Slovenia. Table : Econometric results for all Frenc exporting firms towards EU27 year 2004 Value eq Select eq. ln(firm productivity) *** 0.224*** ln( ) 0.203*** 0.*** ln(distance) *** -0.28*** ln(θ) NS *** Country fixed effects : Reference Belgium Te Neterlands *** *** Germany *** *** Italy 0.45 NS -0.60*** United Kingdom ** *** Ireland -.564*** -.336*** Denmark *** -.092*** Greece NS *** Portugal -0.59*** *** Spain NS *** Sweeden -.096*** -.278*** Finland -.089*** -.327*** Austria -.570*** -.430*** Malta *** -.820*** Estonia -.758*** -.829*** Latvia -.956*** -2.09*** Lituania *** -.866*** Poland -.502*** -.483*** Czec Republic -2.57*** -.766*** Slovak Republic -2.07*** -2.24*** Hungary -.774*** -.72*** Slovenia *** *** Cyprus -.806*** -.78*** Sub sector fixed effects : yes Log likeliood = Prob > ci2 = Number of obs = 6200 Censored obs = Uncensored obs = 2663 *** signi. at % level; ** signi. at 5 % level; NS non signi Teir probability of exporting to one of tese markets is greatly inferior to tat of exporting to oter markets. Can suc differences be explained by Frenc firms' lack of knowledge of tese markets, by specific market requirements, by language barriers...wic result in iger entry costs? Inversely, Belgium is te most accessible market for Frenc exporters. However, te country fixed effect on te exported value is not significantly different in comparison wit Italy, Spain or Greece.

5 5 Tese results seem to suggest tat differing market structure caracteristics exist amongst EU members in 2004, in addition to geograpic proximity and te size of tese commercial partners. B. Does te export experience decrease te impact of trade barriers? According to Kneller and Pisu [3], export market experience is likely to contain tree main dimensions, te lengt of time te firm as been exporting, te number of market it serves and te intensity wit wic it serves tose markets. Due to lengt constraints, we focus ere only on te export intensity measured by te sare of exports in te total turnover of te firm. As Kneller and Pisu [3], we suggest to distinguis tree categories for te export intensity : less tan 5%; 5-50%; more tan 50%. In te second set of estimations, in order to assess te differentiated impact of te trade costs according to export experience, we cross te trade costs variables (i.e distance and country fixed effects) wit tese tree categories of export intensity. In Table 2, we report results for distance. 2 It appears tat as experience rises te impact of distance falls. Hence, distance as no impact on te export decision for te more export oriented firms. Wile distance still as a significant impact on te value of export, tis impact is significantly lower tan for less experienced firms. Concerning te country fixed effects in te selection process, results sow tat remaining trade costs matter less for te most export oriented firms tan for te oter firms watever te destination market. Table 2: Impact of distance on te export of firms according to teir export experience year 2004 ln(distance of te firm) Value eq Select eq. low export intensity < 5% *** -0.33*** medium export intensity6-50% *** *** ig export intensity > 50% *** NS V. CONCLUSION Te aim of tis article was to provide an analysis of Frenc exports to European markets using data for individual Frenc firms (from customs and EAE sources). It sougt to ascertain to wat extent te European market is fragmented for Frenc exporters. Our analysis sows tat access conditions to te various European markets are not identical for Frenc companies. Distance and size of te importing country explain partly tese differences : oter trade costs remain. Tese results sould support te idea tat te EU market is still fragmented for Frenc firms. But tese trade frictions don t matter to all firms in te same way. Te iger te firm experience, te lower te impact of trade costs. REFERENCES. Henry de Fraan B, Vancauteren M (2006) Harmonisation of food regulations and trade in te single market: Evidence from disaggregated data. ERAE 33: Cevassus-Lozza E, Latouce K, Makovic D, Unguru M, (2007) How muc do tariff and non-tariff measures explain te border effect at entry to te EU market? AAEA Proc, Annual meeting of te American Agricultural Economics Association, Portland, Oregon. 3. Head K, Mayer T (2000) Non-europe: Te magnitude and causes of market fragmentation in te EU. Review of World Economics 36: Anderson JE, van Wincoop E (2004) Trade costs, Journal of Economic Litererature, 43(3): Mac Callum J (995) National Borders Matter: Canada-U.S. Regional Trade Patterns. Te American Economic Review 85(3): Mayer T, Zignago S (2005) Market Access in Global and Regional Trade. CEPII Working Paper No , January 7. Bernard A, Jensen B, Redding S, Scott P (2007) Firms in international trade. Journal of Economic Perspectives 2: Eaton J, Kortum S, Kramartz F (2004) Dissecting trade: Firms, industries, and export destinations. American Economic Review. Papers and Proceedings, 94: Melitz M J (2003) Te impact of trade on intra-industry reallocations and aggregate industry productivity. Econometrica 7: Caney T (2008) Distorted gravity : Te intensive and extensive margin of international trade. American Economic Review fortcoming: 9.. Roberts MJ, Tybout JR (997) Te decision to export in colombia: An empirical model of entry wit sunk costs. American Economic Review 87: Bernard A, Eaton J, Jensen JB, Kortum S (2003) Plants and productivity in international trade. American Economic Review, 93: Kneller and Pisu (2007) Export barriers : Wat are tey and wo do tey matter to? Researc paper series, 2007/2, Leverulme Centre, Te University of Nottingam. 4. Greenaway D, Kneller R (2007) Exporting, productivity and agglomeration. European Economic Review In Press, Corrected Proof. 5. Cevassus-Lozza E, Galliano D (2003) Export Spillovers, Firm Organization and Export Beaviour : Evidence from te Frenc Food Industry. Regional Studies 37 : Address of te corresponding autor: Autor: Emmanuelle Cevassus-Lozza Institute: INRA - LERECO Street: Rue de la Géraudière BP 7627 City: 4436 Nantes Cedex 3 Country: France cevassus@nantes.inra.fr 2. All te oter results are available upon request.