What explains modes of engagement in international trade? Conference paper for Kiel International Economics Papers 2011 Current Version: June 2011 Natalia Trofimenko Kiel Institute for World Economy Hindenburgufer 66 24105 Kiel, Germany Phone: +49 431 8814-245 Fax: +49 431 8814-500 Email: natalia.trofimenko@ifw-kiel.de Horst Raff Christian-Albrechts-University Wilhelm-Seelig-Platz 1 24098 Kiel, Germany Tel.: +49 431 880-3282 Fax: +49 431 880-3150 Abstract We employ multivariate probit and fractional multinomial logit models on the micro-data from the World Bank Climate Surveys over 2002-2006 to investigate the determinants of sorting into direct trade and trade through intermediaries and to inspect whether there are differences between exporting and importing behaviours. We find that the factors consistently related to direct engagement in trade both in terms of its occurrence and the extent are size, foreign ownership and access to external sources of financing to finance working capital. The main differences between exporting and importing behaviors seem to have to do with the structure of the firm: importing behavior is strongly linked to the location of the headquarters and the share of domestic sales going to the parent company or subsidiaries. We contribute to the literature by identifying the characteristics associated with engagement in trade in general and in trade through intermediaries in particular and by highlighting the role of access to external sources of financing to finance working capital as a potential factor that restricts firms ability to engage in direct trade. WORK IN PROGRESS. PLEASE DO NOT CITE WITHOUT PERMISSION. 1
Introduction The role of wholesalers and distributors in international trade has attracted increasing attention in the economics literature (Akerman 2010, Blum et al. 2010, Bernard et al. 2010). The reason firms engage in trade through intermediaries stems from high fixed costs of exporting. By trading through intermediaries, firms can reduce these fixed costs but have to incur variable costs, thereby preventing the disappearance of direct exporters. It has been shown that under these circumstances, most productive firms will engage in trade directly, less productive will do so indirectly, with the least productive firms serving the domestic market. Thus, distributors and wholesalers allow even firms who cannot afford risks and costs of exploring a foreign market independently to gain international exposure. The purpose of this study is to use micro-data from the World Bank Climate Surveys over 2002-2006 to investigate the determinants of sorting into different modes of engagement in trade. After a brief review of the most relevant papers and a description of the data, our analysis begins with a multivariate probit model to explain the plant s choice of engagement in trade (exporting vs. importing) and the chosen mode (direct, indirect, or a combination of the two). We find that plants more likely to engage in direct trade are foreign owned and have access to external sources of financing for working capital and that plants with higher productivity are more likely to engage in direct exports. We then undertake a detailed study of how much of the plant s trade is done directly and how much goes through intermediaries. The results from the fractional multinomial logit analysis suggest that larger, more productive, foreign-owned, multi-plant firms with access to external sources of financing tend to end up with a higher share of direct exports and direct imports and that the extent of indirect involvement in trade increases with the share of domestic sales going to multinational companies located in the country. Our study deviates from the existing research in three ways. First, we consider both exporting and importing behaviours of the firm. Second, we model the decision to engage in trade in a way that allows unobserved factors to contribute to the firm s engagement in both exporting and importing and to be correlated with unobserved factors that are associated with the choice to engage in trade through intermediaries. Third, we go beyond considering trade through intermediaries as a discrete choice and study the impact of firm characteristics on the extent of indirect involvement in trade. 2
We contribute to the nascent but expanding literature on the use of intermediaries in trade by identifying the characteristics associated with engagement in trade in general and in trade through intermediaries in particular and by highlighting the role of access to external sources of financing to finance working capital as a potential factor that restricts firms ability to engage in direct trade. In Section 2 we briefly review most relevant contributions to the literature on trade through intermediaries, mentioning papers with a more tangential relationship to our research at the appropriate places during the presentation of results. In Section 3 we describe first an econometric model of discrete firm decision-making concerning trade and the use of intermediaries and then an econometric model that utilizes available information on the exact shares devoted to direct and indirect modes of trade. The first model captures the possibility of cross-equation correlations, i.e. unobservable propensities for firms to get involved in exports and imports and to resort to the use of intermediaries; the second model accounts for the fact that our dependent variables are proportions and, as parts of one total, tend to be automatically negatively correlated. Section 4 describes out dataset, variables used in the analysis and provides an overview of the general patterns observed in the data. Section 5 details out our empirical specification. Section 6 reports our findings. Section 7 summarizes the results of our study, discusses the limitations of our research and considers its implications for policy and future research on the use of intermediaries in trade. Key Background Papers One of the most important recent contributions is the paper by McCann (2010). The author uses the Business Environment and Enterprise Performance Survey (BEEPS) collected for Eastern European countries for 2002, 2005, 2007, 2008 and 2009 to obtain characteristics of indirect exporters and to test whether there is evidence of the sorting into direct and indirect modes of exporting, whereby most productive firms become direct exporters and less productive firms become indirect exporters. The author runs a series of probit and OLS regressions with the dummies for engagement in direct and indirect exports as the main independent variables and finds that indirect exporters exhibit worse characteristics than direct exporters and, at least in some specifications (depending on how one groups firms into direct and indirect categories or which performance measures are being considered) better characteristics than non-exporters. Performance measures that the authors investigates are labor productivity, size in terms of total sales and employment, propensity to import, being foreign owned, engagement in R&D activities, licensing of foreign technology, and 3
propensity to be a multi-product firm. This paper is a productive starting point for the analysis of the differences between direct and indirect exporters and provides some evidence that better firms may be self-selecting into direct exporting. Data that provides information akin to the information covered in BEEPS seems to be a fruitful source for studying the determinants of engagement in trade through intermediaries. In the next session we describe the data collected by the World Bank as part of the Investment Climate Surveys project and how we deploy it. Data, Sample,Variables and Descriptive Analysis We use firm-level data collected by the World Bank as part of the Investment Climate Surveys project (you can read more about the surveys at http://www.enterprisesurveys.org). The sample for each country is representative of the population of firms according to their industry and location. The survey records information on a number of firm characteristics, such as firm s location, industry, ownership structure, employment, etc. More importantly for our analysis, the survey records detailed information on the distribution of sales between domestic and foreign markets where foreign sales are broken down into direct and indirect exports. The data also include information on the sources of financing, which allows us to explore the hypothesis that access to external sources of finance affects the chosen mode of engagement in trade. Our final sample contains 17356 plants from 30 countries and 12 industries. 1 This sample has been derived by eliminating the observations with missing values on the key variables, cleaning data for outliers, and restricting the data to the countries with at least 100 observations. 2 Industries covered are auto and auto components, beverages, chemicals, electronics, food, garments, leather, metals and machinery, non-metallic and plastic materials, paper, textiles, wood and furniture. The data cover the following countries: Algeria, Argentina, Bangladesh, Bolivia, Brazil, Chile, China, Colombia, Ecuador, Egypt, El Salvador, Ethiopia, Guatemala, Honduras, Hungary, India, Indonesia, Kazakhstan, Mexico, Nicaragua, 1 The data are provided at the establishment (plant) level and we use firm, plant and establishment interchangeably. 2 We defined outliers based on the values of studentized residuals from six regressions with dependent variables defined as shares of domestic sales, direct exports, indirect exports, imports from domestic sources, direct imports and indirect imports and firm characteristics as (total sales, employment, share of foreign relative productivity, foreign ownership, and other variables to be included as determinants of the modes of trade in the formal analysis) as independent variables. Observations with studentized residuals falling outside of the (-2.5; +2.5) interval are defined as outliers. 4
Pakistan, Paraguay, Peru, Philippines, Poland, South Africa, Thailand, Turkey, Uruguay, and Vietnam. On average 37% of firms are exporters, ranging from 23-24% in industries like beverages or auto and auto components to 50% in garments. About three quarters of exporters do so directly. Share of firms who export only through distributors is as low as 10% in industries metals and machinery, electronics and chemicals and pharmaceuticals and as high as 20% in industries like food, textiles, furniture and other manufacturing goods. About 10% of exporters engage in both modes of exporting. On average 40% of firms are importers, ranging from 14% in auto and auto components to over 50% in paper. About 55% of importers import directly and about 30% import only through distributors, with the remaining 15% engaging in both modes of importing. Whereas only 4% of importers in auto and auto components engage in both modes of importing, in other industries the numbers are closer to 10% (20% in chemicals and pharmaceuticals ). About one fifth of firms engage in exporting and importing simultaneously, especially in industries like textiles, leather, and garments (26, 29 and 34 percent respectively). Export intensity varies between industries, from the median of about 10% in paper to nearly entire production in garments and leather. In general, firms who export only directly export a higher share of their production than the exporters through distributors do, although there is a large variation in the size of the gap between industries: from a couple of percent in beverages to 20-30% in electronics. The gaps between direct and indirect traders are even more conspicuous when we look at importers, although there are large crossindustry differences, just as in the case with exporting. The analysis variables are shares of domestic sales, direct exports, indirect exports, imports from domestic sources, direct imports and indirect imports. The unique feature of this data set is that it allows us to look at the use of intermediaries in both exports and imports. trade is defined as the sales to (or imports of materials from) another firm located in the same country who exports (imports). Control variables are mainly drawn from the existing literature and have been shown to have possible effects on export supply and import demand at the firm level. Total sales and employment are included to control for firm size. Relative productivity is constructed as the ratio of the firm s sales per worker and the median value of sales per worker for the same industry in the country. Foreign ownership share is included to control for the possibility that 5
foreign owned firms may have better network opportunities and can therefore have a different propensity to engage in trade, especially direct trade, than domestically owned firms. Share of state ownership is included to control for the differences in incentives to engage in trade between private and state enterprises. To control for the network opportunities, we also include a dummy variable equal to one for establishments that belong to a firm with additional plants located abroad. We include a dummy variable to identify establishments that have their headquarters onsite. To capture the structure of the firm to which an establishment belongs, we include shares of domestic sales going to multinational companies located in the country, as well as sales to the parent company or subsidiaries since data on trade through intermediaries is often criticized for being unclear about the extent to which it includes intrafirm sales. Our data, therefore, allow us to claim with a degree of certainty that the information reported as indirect exports excludes sales to headquarters, for example. Finally, ours is the first study to include access to external sources of financing as the determinant of the mode of exporting. Access to external sources of financing is defined as the share of local commercial banks, foreign owned commercial banks and leasing arrangements in financing working capital and new investments. Descriptive analysis of our data suggests a number of interesting features. The results from regressions of firm characteristics on the dummy variables to indicate the mode of trade suggest that there are significant differences between firms who engage in different modes of trade (direct and indirect) as well as between traders and non-traders. As shown in Table 1, the differences with non-traders are particularly pronounced in terms of size and productivity. Firms that trade through intermediaries are no different from non-traders in terms of foreign ownership and, in the case of exporting, in terms of access to external sources of financing, although these two factors seem to be particularly important to distinguish direct traders from indirect ones. Empirical Strategy A. Multivariate Probit The goal of the paper is to build a picture of the type of the establishments that are most likely to engage in trade through intermediaries and to compare these establishments to those that engage in trade directly. The challenge of this type of analysis is that there may be unobserved factors associated with each mode of engagement in trade that are likely to be correlated with other modes of trade. For example, unobserved factors V may contribute to firm s 6
engagement in both exporting and importing. These unobserved factors may be further correlated with the unobserved factors W that are associated with the decision to trade through an intermediary. Thus, a consistent estimator must account for correlations between the errors of the models which determine the type of trade that a firm conducts exports or imports and the models which determine how exactly the firm trades, i.e. whether it does so directly or through an intermediary. This is achieved by assuming that the error terms of the full recursive system, consisting of the reduced form equations for exporting and importing behaviors have a multivariate normal distribution. Such assumption allows us to estimate the model using a multivariate probit specification where the correlations between the error terms are unrestricted. Additional advantage of multivariate probit with discrete indicators of the types and modes of engagement in trade and cross-correlation between equations is that this specification allows not only the presence or absence of engagement in trade, but also for the joint occurrence of exporting and importing. Hence, we estimate a recursive system of 6 equations with an equation for each type of engagement in trade (export/import) and each mode (direct/mixed/indirect). Notwithstanding the complexities involved in the interpretation of the results of these models, multivariate probit appears to be the appropriate procedure, since specification tests indicate that there is a significant cross-equation correlation. Unobservables which affect the propensity to export are positively related to those which affect importing, irrespective of the mode of engagement in trade, although some correlations are larger than others. We can interpret the matrix of correlations as indicative that firms generally have unobserved propensities for trading and involving intermediaries. B. Fractional Multinomial Logit Our data set provides information on the exact breakdown of a firm s sales: domestic sales, indirect exports and direct exports (measured as shares adding to one). Similar information is provided for imports of materials: share of materials sourced from domestic sources, direct imports and indirect imports. Multivariate probit disregards this quantitative information by grouping firms together based on whether corresponding shares were above zero or not. In the final stage of our analysis we investigate how firms allocate their sales between foreign and domestic markets and to what extent they use trade through intermediaries or direct exporting (similar investigation is conducted for imports). 7
Below we provide detailed information about the specification for exports. Similar logic holds for imports. We estimate a system of simultaneous equations with the shares of domestic sales, direct exports and indirect exports as dependent variable. Several peculiarities should be taken into account to estimate such a system. First, each of the dependent variables is a fraction between zero and one. Second, the sum of the three variables is exactly equal to one. Third, linear simultaneous equations assume that the marginal effect of any explanatory variable is constant which may or may not be appropriate. To guarantee (1) that the predictions on the shares of domestic sales, direct and indirect exports are between zero and one, (2) that the sum of the shares is exactly equal to one, and (3) that non-linear relationships between the dependent and explanatory variables and decreasing marginal effects are allowed, we use fractional multinomial logit. This approach was developed by Papke and Wooldridge (1996) in the context of participation rate in pension plans and extended to multiple fractions by Sivakumar et al. (2002) in the context of commodity flows. In the context of firm choice on destination markets (domestic and/or foreign) and modes of exports (direct and/or indirect), let 0 1 and y qi I i= 1 y qi = 1, where q is an index that represents the firms and i is an index that represents the firm choices (q=1,2,.,n, where N is the sample size, and i=3, which is the firm choices between domestic sales, direct exports, and indirect exports). The population model is assumed to be E( yqi xq 1, xq2,..., xqi ) G( β, xq 1, xq2,..., xqi ) =, where x qi is a vector of explanatory variables for y qi, and β are vectors of model parameters. For ensuring ( qi q ) E y x to lie between 0 and 1 and sum of y qi across i to be exactly 1, the existing multinomial logit function can be selected to form function G( ). Thus, one may have: exp E( yqi xqi ) = G( yqi xqi ) = 3 exp j = 1 ( xqiβi ) ( xqjβ j ) where xqiβ i is a utility function for firm choice fraction y qi. Coefficients obtained from the estimation of the fractional logit model tell us something about the tendency of firms to devote more or less resources to domestic sales, direct or indirect exports and similar information for imports. 8
The results from the multivariate probit and the fractional logit models are of interest as they allow us to make statements concerning the exporting and importing behaviour of the establishments and concerning the degree to which different types of establishments tend to use intermediaries in trade. Results We begin by considering the results of the model where mixed strategy is separated into a category of its own (in principle, since multivariate probit allows for joint occurrence of categories, this is not necessary). Table 2A reveals strong positive association between firm s size in terms of total sales and employment, foreign ownership, as well as access to external sources of financing for working capital and the engagement in direct trade. Firms with a higher share of domestic sales going to MNCs located in the country are more likely to have at least part of their trade conducted without the aid of intermediaries. Comparing exporting and importing behavior, we notice lots of similarities, the exception being the importance of the share of domestic sales going to the parent company or to the subsidiaries for importing behavior of the establishment and the location of the headquarters. It appears that importers are more likely to be an establishment with the headquarters located elsewhere. In Table 2A we presented the results of an analysis which disregarded multivariate probit s ability to account for joint occurrence of direct and indirect modes of trade (mixed strategy was taken as a separate category). In Table 2B we present results from the analysis in which we keep only four equations in our recursive system: observations previously presented as a mixed strategy will now be included in equations for both direct and indirect modes of trade. Table 3 reveals that larger, more productive, foreign owned multi-plant firms with access to external sources of financing tend to end up with a higher share of direct exports and direct imports. The extent of indirect involvement in trade increases with the share of domestic sales going to MNCs located in the country. Table 3 supports the finding of the discrete analysis that the main differences between exporting and importing behaviors seem to have to do with the structure of the firm. For example, we find that establishments engaged more in importing materials are more likely to be part of a bigger firm, with the headquarters located elsewhere. Firms with a larger share of domestic sales going to the parent company or subsidiaries are likely to import more materials, especially indirectly. 9
In Table 4 we restrict our analysis to only those firms who engage in trade (column 1), only exporters who engage in either direct or indirect trade (column 2) and only importers who engage in either direct or indirect trade (column 3). In the specification where we look at the tendency to engage in direct or indirect trade in general (column 1), without the breakdown by exporting and importing behaviour, we redefine the dependent variable to mean the shares of direct and indirect trade in total trade. Once we exclude firms with mixed strategy, we see that the factors that distinguish direct traders from indirect traders are size, foreign ownership share, existence of plants abroad and access to external sources of financing. Conclusions In this paper we present results from multivariate probit and fractional logit analyses aimed at explaining the choice of the modes of engagement in exports and imports at the firm level. We find that the factors consistently related to direct engagement in trade are size, foreign ownership and access to external sources of financing to finance working capital. Our results also establish a few patterns regarding importing behavior at the microlevel. Specifically, we find that establishments engaged in importing materials are more likely to be part of a bigger firm, with the headquarters located elsewhere. Firms with a larger share of domestic sales going to the parent company or subsidiaries are more likely to be import materials, especially indirectly. The main shortcoming of our research is the fact that our data do not allow us to establish a causal relationship between firm characteristics and the mode of engagement in trade. Secondly, we have not taken into account the potentially endogenous nature of foreign ownership and access to external sources of finance. This can be done, for example, if we replace the share of foreign ownership and the share of financing coming from external sources by discrete variables indicating whether the firm is foreign owned and whether it has access to external sources of financing and then expanding the recursive system to include independent equations for the foreign ownership and access to external sources of financing. Exploring this strategy remains on our research agenda. 10
Table 1 Exports Imports Mixed Mixed Relative Productivity 0.11 0.07 0.04 0.13 0.09 0.03 Total Sales 2.31 1.82 0.72 2.37 2.02 0.52 Employment 1.67 1.40 0.49 1.61 1.42 0.31 Share of Foreign Ownership 0.16 0.07 0.01 0.18 0.10 0.00 Access to External Sources of Financing - Working Capital Access to External Sources of Financing - New Investments 0.07 0.06 0.01 0.08 0.08 0.02 0.07 0.05 0.01 0.07 0.07 0.02 Values are coefficients from regressions with rows as dependent variables and independent variables defined as dummies for direct, mixed, and indirect engagement in trade. Separate regressions for exporting and importing behavior. Coefficients to be interpreted as differences relative to the omitted category (firms not engaged in exports for the first three columns or imports for the last three columns). Controls for country, industry and year included. Statistically insignificant values in cursive. 11
Table 2 Exporter Mixed Exporter Exporter Importer Mixed Importer Importer Log(Total Sales) 0.07 0.04 0.01 0.14 0.05 0.03 Log(Employment) 0.46 0.15 0.00 0.29 0.14-0.09 Relative productivity 0.23-0.12 0.00 0.09 0.02-0.08 Share of foreign ownership 0.65-0.17-0.41 0.67-0.06-0.51 Share of state ownership -0.34-0.08-0.23-0.06-0.04 0.06 Whether or not the firm has plants abroad 0.61 0.18-0.19 0.61 0.07-0.31 Whether or not the headquarters are located in this 0.10 0.05-0.06-1.40-0.70-0.74 establishment Share of domestic sales going to MNCs located in the country 0.25 0.38 0.08 0.40 0.56 0.12 Share of domestic sales going to parent company or -0.13 0.03 0.10 0.17 0.26 0.11 subsidiaries Access to External Sources of Financing - Working Capital 0.13 0.04 0.00 0.27 0.17 0.00 Access to External Sources of Financing - New Investments 0.06 0.00-0.03 0.12 0.05 0.04 Age 0.00 0.00 0.00 0.00 0.00 0.00 Values are coefficients from a recursive system of six equations (dependent variables in the column headings, independent variables in the row headings). Statistically significant values in bold. Positive values indicate that firms with this characteristic are more likely to engage in this particular type and mode of trade, negative values the opposite. 12
Table 2B Exporter Exporter Importer Importer Log(Total Sales) 0.09 0.04 0.13 0.07 Log(Employment) 0.42 0.07 0.30 0.00 Relative productivity 0.18-0.06 0.20-0.18 Share of foreign ownership 0.76-0.15 0.59-0.27 Share of state ownership -0.45-0.08-0.10 0.06 Whether or not the firm has plants abroad 0.55 0.01 0.63-0.13 Whether or not the headquarters are located in this 0.09-0.00-1.53-0.94 establishment Share of domestic sales going to MNCs located in the country 0.36 0.37 0.46 0.35 Share of domestic sales going to parent company or 0.00 0.19 0.23 0.27 subsidiaries Access to External Sources of Financing - Working Capital 0.13-0.06 0.29 0.10 Access to External Sources of Financing - New Investments 0.05-0.00 0.11 0.05 Age 0.00 0.00-0.00 0.00 Values are coefficients from a recursive system of four equations (dependent variables in the column headings, independent variables in the row headings). Statistically significant values in bold. Positive values indicate that firms with this characteristic are more likely to engage in this particular type and mode of trade, negative values the opposite. 13
Table 3 Share of Exports Share of Exports Share of Imports Share of Imports Log(Total Sales) 0.10 0.08 0.21 0.10 Log(Employment) 0.75 0.29 0.38 0.01 Relative productivity 0.08-0.23 0.29-0.04 Share of foreign ownership 1.42-0.05 1.19-0.10 Share of state ownership -0.62-0.56-0.36-0.01 Whether or not the firm has plants abroad 0.61 0.28 0.76-0.13 Whether or not the headquarters are located in this 0.06-0.06-2.00-1.82 establishment Share of domestic sales going to MNCs located in the country 0.17 0.44 0.40 0.49 Share of domestic sales going to parent company or -0.24 0.16 0.06 0.39 subsidiaries Access to External Sources of Financing - Working Capital 0.23 0.21 0.44 0.14 Access to External Sources of Financing - New Investments 0.02-0.12 0.10 0.19 Age -0.01 0.00 0.00 0.00 Values are coefficients from fractional multinomial logit regressions. Separate regressions for exports and imports. Dependent variables shares of domestic sales (materials bought from domestic sources) and direct and indirect exports (imports). Additional controls for country, industry, and year. Statistically significant values in bold. Positive values indicate that firms with these characteristics tend to end up with a higher share of direct(indirect) exports(imports). 14
Table 4 Trade vs. Trade Exports vs. Exports Imports vs. Imports Log(Total Sales) 0.12 0.12 0.13 Log(Employment) 0.43 0.38 0.41 Relative productivity 0.35 0.20 0.41 Share of foreign ownership 1.33 1.17 1.30 Share of state ownership -0.27 0.06-0.30 Whether or not the firm has plants abroad 0.84 0.47 0.71 Whether or not the headquarters are located in this 0.14 0.00-0.35 establishment Share of domestic sales going to MNCs located in the country 0.08-0.02 0.20 Share of domestic sales going to parent company or -0.41-0.32-0.19 subsidiaries Access to External Sources of Financing - Working Capital 0.32 0.36 0.32 Access to External Sources of Financing - New Investments 0.01 0.11-0.02 Age 0.00-0.01 0.00 Values are coefficients from three fractional multinomial logit estimations. Dependent variables are shares of direct and indirect trade (exports, imports) in total trade (exports, imports). Additional controls for country, industry, and year. Statistically significant values in bold. Positive values indicate that firms with these characteristics tend to end up with a higher share of direct trade (exports, imports). 15