Size, Trade, Technology and the Division of Labor

Nuno Limão and Yang Xu

No 28969, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We model the implications of the classical ideas that larger markets allow for a finer division of labor and this division feeds back into larger market size. Market size affects specialization due to firm-level increasing returns to scale arising from fixed costs of adopting intermediate-intensive technologies. The impacts are magnified in general equilibrium by an endogenous multiplier—due to input-output linkages in a roundabout structure—and a selection effect due to heterogeneous fundamental productivity and entry costs. Market size expansions imply (i) larger real income gains than under fixed specialization; (ii) an increase in the aggregate variable cost share for intermediates and a decrease for labor; (iii) increased concentration; (iv) increased average productivity for survivors; and (v) an increase in the intermediate trade share. We derive similar results for intermediate productivity improvements. The effects in (ii)-(v) are absent in a similar model with exogenous specialization. In a calibration to U.S. manufacturing in 1987-2007 we isolate trade and intermediate productivity shocks, quantify their effects. Trade cost reductions increased effective market size by 7 log points (lp) and generated (i) a real income gain 1.4 times higher than under exogenous specialization; (ii) increases in the intermediate share in production and trade of 2 lp and a reduction in the labor share of value added of similar magnitude. Two counterfactuals highlight the importance of industrial and trade policy. First, a tax that induces firms to specialize increases real income; so the initial equilibrium is inefficient. Second, an increase in trade costs of 16 lp—similar to the recent trade war—reduces market size and real income substantially: almost half way to trade autarky.

JEL-codes: F1 F4 L11 O24 O25 O51 (search for similar items in EconPapers)
Date: 2021-06
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