Uncertainty and Entry into Export Markets

Abstract

We face uncertainty in most economic decisions we take. This is particularly true in the case of a firm entering a foreign market where there is uncertainty about the size of the market, the distribution channels, the adequacy of the firm's product to local tastes, etc. Despite its obvious importance, this ingredient appears to have been largely overlooked by the literature explaining the direction and volume of international trade flows. We incorporate this informational uncertainty into a model with heterogeneous firms similar to the one proposed by Melitz (2003). The model exhibits informational externalities that arise via informational complementarities: in markets with less uncertainty, the most productive firms always find optimal to enter. Once a firm enters that foreign market, her success/failure reveals information to other domestic firms who, given the new information, optimally decide whether to enter. We characterize the conditions under which, given initial entry, informational externalities are strong enough to reach an equilibrium with full information. The model delivers an explanation for the recent dynamic evolution of trade flows, at the intensive margin at the country level and the extensive margin at the firm/product level. The model also provides insights on the persistence of bilateral trade flows, zero trade flows, and why we observe empirically less entrance by small firms than the Melitz model predicts.

Keywords: firm heterogeneity, International Trade, Uncertainty, Informational Externalities

JEL Classification: D21, D80, F12