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CESIS - Centre of Excellence for Science and Innovation Studies, Royal Institute of Technology KTH/CESIS Working Paper Series in Economics and Institutions of Innovation

No 81:
Entry costs and adjustments on the extensive margin - an analysis of how familiarity breeds exports

Martin Andersson ()

Abstract: Fixed entry costs play an important role to explain the heterogeneity among exporters in terms of the geographical scope of their export activities. Yet, the existing literature has paid little attention to the nature and variation of such costs across different markets. This paper proposes a link between familiarity and fixed entry costs, such that (all else equal) the cost of entering a familiar market is lower than entering an unfamiliar one. A testable implication of this is that familiarity should primarily affect the extensive margin (number of exporters) of exports. This hypothesis is tested by estimating a gravity equation on a panel that describes Swedish firmsí exports to 150 destination countries over a period of seven years. The results are consistent with the hypothesis and show that the effect of familiarity on the volume of aggregate exports is primarily due to adjustments on the extensive margin. Adjustments on the extensive margin are large and have a significant impact on aggregate export volumes. The findings do not only help to clarify the nature and variation of fixed entry costs across destination markets: they also suggest a precise mechanism through which familiarity affects trade.

Keywords: international trade; fixed entry costs; transaction costs; gravity models; extensive margin; intensive margin; heterogeneous firms; (follow links to similar papers)

JEL-Codes: F10; F14; R12; (follow links to similar papers)

35 pages, February 5, 2007

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