Heterogeneous firms: an application

1. Heterogeneous firms: an application José C. Fariñas (Universidad Complutense Madrid) X Workshop SIEPI Università di Perugia January 26-27, 2012

2. Introduction • Micro level studies of production units for a wide range of countries have documented substantial heterogeneity across units • This heterogeneity is reported in virtually all relevant performance measures (most notably size and productivity) • Productivity differences are: • Of large size: average TFP of the 90th percentile is 1.9 times the average TFP of the 10th percentile (Syverson, 2004) • Persistent: autorregresive coefficients of 0.6-0.8 (Foster, Haltiwanger and Syverson, 2008) • Within narrowly defined industries: a plant one s.d. above the mean plant is 75% more productive drops to 66% when controlling for 450 industries (Bernard, Eaton, Jensen and Kortum, 2004)

3. The survey by Bartelsman and Doms (2000) points out a large and very broad list of factors making some firms more productive than others: • Exporting • Regulation • Management/ownership • Technology • Human capital • The discovery of large and persistent productivity differences has shaped research agendas in various fields in recent years. • One of the consequences of this has been the introduction of heterogeneity as a basic ingredient of recent theoretical and empirical work. • Objective: to examine how sourcing strategies of firms are driven to a large extent by productivity differences

4. An example: the iPad2 Assembled in China by Taiwan-base Foxconn (since the end of 2011 also in Brazil)

5. Printed Circuit Board

6. A taxonomy of decisions • The choices for a firm deciding where and how to engage a portion of its production process: • Two locations • Two ownership structures • DOBLE ENTRY MATRIX: Location of the production process Home country Foreign country In-house Ownership Structure Outsource

7. Theory

8. Sourcing strategies by firms: theoretical approach • There is a number of approaches to investigate the organizational decisions of firms • The transaction cost analysis implicit in Dunning (1977) eclectic approach • The property-rights approach with incomplete contracts developed from the by Grossman and Hart (1986) • I take as reference two papers that use the property-right approach • Antràs (2003), “Firms, contracts and trade structure”, QJE • Antràs and Helpman (2004), “Global sourcing”, JPE.

9. Sourcing strategies by firms: theoretical approach • Basic tradeoff embodied in these studies: depends on the comparison of surplus players obtain under cooperation and the outside option (what they get if the relationship breakdown) • First agent (I): final good producer who owns the technology to produce the final good. It supplies the input h (headquarter services) • Second agent (S): supplies component m; highly specialized and tailored to the need of the final good producer.

10. I and S bargain ex-post for the payment of component m to S. • Contracts are incomplete (no contract that fully describe the nature of the relationship between S and I to make it enforceable in a court) • Production of y requires two specialized inputs h and m. Parameter η measures the headquarter intensity of production.

11. What is the outcome of the ex-post bargaining? • A) if S is an independent supplier: the revenue is divided in proportion to the bargaining power of each player. • B) if S is integrated into I company: final good producer is able to bargain for a higher fraction of the revenue than under outsourcing. • C) however, final good producer might not prefer integration if the organizational form has an effect on the revenue (S has less incentive to produce high quality component m if she gets a smaller share of revenue)

12. - when production is intensive in h: integration does a better job

13. Antràs and Helpman (2004) introduce firm heterogeneity into each sector and fixed cost that vary by organizational form. Firms can make two endogenous organizational choices: - integration decision (integration vs. outsourcing) - location decision (domestic vs. foreign) • As before two agents are engaged in production: - final-good producers are located at home - firms producing components can be located at home (D) or in the foreign country (F). - Firms producing components can be vertically integrated (V) or not: outsourcing (O)

14. Fixed organizational costs of search, monitoring and communication are ranked as follows: fvF> foF>fvD>foD - regardless of ownership structure, fixed costs are higher in the foreign country - given location, organizational costs of an V-firm > costs of an O-firm

15. Industry equilibrium predictions: Location and integration decisions will depend on the level of firm productivity (λ) and on the relative input intensity of the industry, according to the following pattern: Component intensive industry: Density function Outsource in D Exit Outsource in F (arm’s length trade) λ, Productivity level

16. Foreign Outsourcing Profits Domestic outsourcing Exit Domestic Foreign outsourcing Outsourcing Productivity Fixed costs The slopes depend on the relative wage of F/D : Profits rise faster with productivity if wages are lower abroad.

17. Industry equilibrium predictions: Location and integration decisions will depend on the level of firm productivity (λ) and on the relative input intensity of the industry, according to the following pattern: Headquarter intensive industry: Integrates in F (FDI) (intrafirm trade) Outsource in F (arm’s length trade) Outsource in D Integrates in D Exit λ, Productivity level

18. Empirical application

19. Measuringsourcingstrategies • Domestic outsourcing firms subcontracting some stages of their production process to external suppliers which are located in the domestic market • Offshoring firms doing a similar operation in international markets • performed with a non-affiliated company (arm’s length trade) • performed with an affiliated supplier (intrafirm trade)

20. ESEE survey Questionnaire: • “Value of purchased products and components subcontracted to external suppliers and tailored to the needs of the firm” (in some cases the firm provides materials) • Whether these purchases come from local or foreign suppliers • Foreign affiliated/unaffiliated suppliers.

21. CLASSIFICATION: • [2] Firms outsourcing at home • [3] Offshoring firms • [4] Offshoring from unaffiliated suppliers (arm’s length trade) • [5] Offshoring from affiliated suppliers (intra-firm trade) • [1] Firms integrating at home (Neither outsource at home nor offshore abroad)

22. Some descriptive evidence Participation rate for domestic outsourcing and offshoring firms (%) 40% 30% 5%

24. Testing procedure • Perform comparisons of productivity distributions of different groups of firms • The procedure is based on non-parametric techniques and has been previously used in Delgado, Fariñas and Ruano (2002, JIE) and Fariñas and Martin, (2010, WE) • Let define two productivity distributions: • F, productivity distribution of offshoring firms • G, productivity distribution of firms not performing offshoring (either they integrate or outsource at home) • According to predictions of Antràs and Helpman (2004) either for component intensive industries or headquarter intensive industries, the distribution F should dominate the distribution G.

25. Stochastic dominance of F relative to G requires two statistical conditions to be satisfied: • - First, both distributions are not identical, i.e. the null hypothesis H0 : F(z)-G(z) = 0 can be rejected; • Second, the sign of the difference is as expected, i.e. the null hypothesis H0 : F(z)-G(z)  0 cannot be rejected • (the variable z represents independent random samples drawn from cdf’s F and G, of size n and m respectively) • These two-sided and one-sided tests can be performed respectively using the Kolmogorov-Smirnov test statistics: • To further illustrate the comparisons between the productivity of different groups of firms we have graphed their smooth sample distribution functions.

26. Productivity measurement • Database: Encuesta sobre Estrategias Empresariales (ESEE) • Panel of manufacturing firms containing 21,098 observations over the period 1990-2005 that correspond to an average number of 3,000 firms per year. • The dataset is representative of the population of Spanish manufacturing firms • Large firms (more than 200 employees) • Small firm (between 10-200 employees), random sampling scheme • Firm productivity is defined by an index of total factor productivity for each firm over the period 1990-2005. The index proposed is an extension of the multilateral total factor productivity index proposed by Caves, Christensen and Diewert (1982).

27. The expression of total factor productivity for firm f, at time t, in a given industry is: • Where, yft is the output of firm f at time t; xrft is the quantity of input r labor, materials and the stock of capital, corresponding to firm f at time t; ωrτis the cost share of input r. Firms are classified in two size groups of small and large firms, = 0 ,1 • The index measures the proportional difference of TFP for firm f relative to a given reference firm. The reference firm varies across industries (NACE classification at the two-digit level). When observations are pooled, average TFP differences across industries are removed.

28. Empirical results Figure 2 Productivity differences between offshoring and non-offshoring firms (Smooth sample distribution function)

30. Table 2 Productivity level differences between offshoring firms and non-offshoring firms: hypotheses test statistics (All firms) Average difference at the median: 7.5 percent

31. 6.5 percent

32. 4.4 percent.

33. Robustness checks: additional controls… • We check whether the productivity premium of offshoring firms is robust to other characteristics that are associated with firm productivity. • Offshoring can be correlated with omitted variables such as size, innovation, human capital, which may be inflating the magnitude of the productivity premium.

34. Additional controls: • ln TFPit is the log of TFP, where average productivity differences across industries are removed • Offitis a dummy variable for the current sourcing status (1 if firm i out sources in year t, 0 else); • Zit is a vector of control variables that includes: • the log of number of employees and its squared value to measure firm size • a dummy variable indicating Foreign ownership (1 if firm has 50 percent or more of equity owned by foreign capital) • the log of firm age • a full set of year dummies to control for common shocks to all firm • the log of the ratio of labour cost per hour to proxy human capital • Industry characteristics taken into account in the index measure of productivity. • Additionally, to control for unobserved firm heterogeneity due to time-invariant firm characteristics, the equation is estimated with fixed firm effects.

35. Coefficients measure productivity differences Relative to firms integrating at home: Domestic outsourcing firms have lower productivity Firms integrating abroad have the highest average productivity

36. Summary • Firm productivity differs systematically across groups of firms with different sourcing strategies. • The productivity of firms engaged in offshoring outperforms the productivity of firms either integrating or outsourcing at home • More generally, the ranking of firm productivities is consistent with the model of global sourcing proposed by Antràs and Helpman (2004): • Lowest productivity: local outsourcing firms • Most productive: firms integrating abroad • Vertically integrated firm > outsourcing firms • Productivity differences are robust to the control of a number of firm characteristics and robust to different measurement methods (GMM production estimates; Olley and Pakes, etc.)