Firm Entry, Trade, and Welfare in Zipf's World

49 Pages Posted: 30 Aug 2010

See all articles by Julian di Giovanni

Julian di Giovanni

Federal Reserve Banks - Federal Reserve Bank of New York; Universitat Pompeu Fabra - Department of Economics and Business; Barcelona Graduate School of Economics (Barcelona GSE); CREI and Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR)

Andrei A. Levchenko

University of Michigan - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: August 2010

Abstract

Firm size follows Zipf's Law, a very fat-tailed distribution that implies a few large firms account for a disproportionate share of overall economic activity. This distribution of firm size is crucial for evaluating the welfare impact of economic policies such as barriers to entry or trade liberalization. Using a multi-country model of production and trade calibrated to the observed distribution of firm size, we show that the welfare impact of high entry costs is small. In the sample of the largest 50 economies in the world, a reduction in entry costs all the way to the U.S. level leads to an average increase in welfare of only 3.25%. In addition, when the firm size distribution follows Zipf's Law, the welfare impact of the extensive margin of trade -- newly imported goods -- is negligible. The extensive margin of imports accounts for only about 5.2% of the total gains from a 10% reduction in trade barriers in our model. This is because under Zipf's Law, the large, infra-marginal firms have a far greater welfare impact than the much smaller firms that comprise the extensive margin in these policy experiments. The distribution of firm size matters for these results: in a counterfactual model economy that does not exhibit Zipf's Law the gains from a reduction in fixed entry barriers are an order of magnitude larger, while the gains from a reduction in variable trade costs are an order of magnitude smaller.

Suggested Citation

di Giovanni, Julian and Levchenko, Andrei A., Firm Entry, Trade, and Welfare in Zipf's World (August 2010). NBER Working Paper No. w16313, Available at SSRN: https://ssrn.com/abstract=1667345

Julian Di Giovanni (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

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Universitat Pompeu Fabra - Department of Economics and Business ( email )

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Barcelona Graduate School of Economics (Barcelona GSE) ( email )

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CREI and Universitat Pompeu Fabra ( email )

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Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

HOME PAGE: http://julian.digiovanni.ca

Andrei A. Levchenko

University of Michigan - Department of Economics ( email )

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Ann Arbor, MI 48109-1220
United States

HOME PAGE: http://alevchenko.com

National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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United Kingdom

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