Heterogeneous intermediate suppliers and product quality under trade and investment liberalization

Abstract

This thesis focuses on the so far neglected area about the behavior of heterogeneous intermediate suppliers in international trade. The supplier of intermediate goods has been either assumed away or treated homogenously in earlier trade models that analyze firm behaviour. My empirical analyses of suppliers in Vietnam as well as in 29 European countries under investment liberalization reveal a vast heterogeneity among the suppliers in term of their both ex ante and ex post abilities. It is the productivity of each supplier that determines which type of final producer it would supply to and the gains it gets from such supplying linkage. Motivated by these empirical findings, this thesis establishes two new theoretical models that incorporate the intermediate sector with heterogeneous intermediate suppliers in the heterogeneous producer model. With this new structure, I’m able to examine the simultaneous equilibria in both sectors and analyze the interdependence between the behavior of the final producers and their suppliers. My first model analyzes the choice of an intermediate supplier in serving different types of final producers, and predicts that more productive suppliers self-select into supplying to multinationals or exporting. A reduction in trade or investment cost would affect its relative preference for these two choices. My second model focuses on the product quality choice of firms that produce multiple products and source their quality-differentiated inputs from various suppliers. This is a novel contribution to the unification of two separate literatures on vertical differentiation and horizontal differentiation of products and offers a better explanation for some new stylized facts in international trade. Specifically, this model explains the variation in a firm’s product range and prices under different market competition conditions and trade liberalization. The major predictions are that: (i) higher ability firms export a larger and higher quality range of products and source their inputs from more suppliers; (ii) the characteristics of a market, including its size, productiveness and skill-intensity would determine the competition level, hence, affect the product choice of exporters to that market; and (iii) under greater competition, a firm’s top quality-, and at the same time, its lowest quality-adjusted priced products would be the most successful ones.