Food Processing Firms, Input Quality Upgrading Eric Tseng and Ian - PowerPoint PPT Presentation

Food Processing Firms, Input Quality Upgrading Eric Tseng and Ian Sheldon and Trade Virginia Tech AAEC Seminar, April 17th, 2015

Motivation - Quality Matters ❖ Quality an important determinant of trade flows (Linder 1961) ❖ Schott (2004) and Hummels & Klenow (2005) link exporter GDP per capita and product quality ❖ Hallack (2006) links product quality to importer GDP per capita ❖ Manova & Zhang (2012) show successful exporting firms in China use higher-quality intermediate inputs to produce higher-quality goods and firms vary quality of produces across destination markets ❖ Vertical product differentiation matters and should be modeled

Motivation - Food Markets ❖ Food markets no longer characterized by homogenous products (Sexton 2013) ❖ Food quality matters, and firms in food industry use vertical product differentiation strategies ❖ Sunk costs related to production capacity and product quality matter ❖ Curzi, Raimondi & Olper (2014) investigate impact of trade liberalization on food product-quality ❖ Trade liberalization in exporting countries leads to faster upgrading of product quality for products closer to technology frontier ❖ On average, EU voluntary food-quality standards have positive effect on rate of quality upgrading

Goals of Analysis ❖ Use modified heterogenous-firms framework allowing for intermediate input markets (Kugler & Verhoogen, 2012) ❖ Extend to focus on food quality and quality of agricultural inputs (Sexton, 2013), the impact of trade liberalization on food product-quality (Curzi et al, 2014) ❖ Examine closely relationship between food product- quality, trade liberalization, and ability of firms to upgrade quality of final goods


 
 Model - Consumers ❖ Consumers: ❖ Utility 
 σ ⎡ σ − 1 ⎤ σ − 1 ( ) ∫ (1) U = q ( ω ) x ( ω ) σ d ω ⎢ ⎥ ⎣ ⎦ ω ∈ Ω ❖ Demand 
 − σ p O ( ω ) ⎛ ⎞ (2) x ( ω ) = Xq ( ω ) σ − 1 ⎜ ⎟ ⎝ ⎠ P


 Model - Firms ❖ Firms ❖ Intermediate agricultural good produced via I production function: 
 I ( A , c ) = A (3) F c ❖ Since intermediate input market is perfectly p I ( c ) = c competitive, then

Model - Firms ❖ Food processors (final good producers) require fixed λ λ investment cost to obtain capability , where is 
 f e 
 G ( λ ) = 1 − λ m k ⎛ ⎞ ⎜ ⎟ drawn from Pareto distribution with , 
 ⎝ ⎠ λ 0 < λ m ≤ λ ❖ Firms must pay fixed costs to enter market, , and also f incur fixed cost of exporting in all periods f x


 
 
 
 
 Model - Firms ❖ Firms use inputs of capability, intermediate agricultural input and φ composite input of specific quality φ ❖ : additional tangible input that affects firm quality choice, i.e., capital equipment required to ensure quality control ❖ Production function for final good is: 
 F ( n ) = n λ a φ (4) MC = φ p I ( c ) λ a MC X = τφ p I ( c ) λ a


 Model - Firms ❖ Food processors constrained by quality choice ❖ Inputs as complements in determining quality of good (Kremer, 1993; Kugler & Verhoogen, 2012) 
 β + 1 β + 1 ⎡ ⎤ ( ) ( ) ( ) (5) q = 1 β 3 λ b 3 φ 3 3 c 3 ⎢ ⎥ ⎣ ⎦


 Model - Firms ❖ The importance of b ❖ is the scope of product-quality differentiation, b approximating fixed costs of investment required to translate capability into product quality ❖ Additional channel impacting firms’ quality choices, where lower restricts available quality choices, b while higher has higher available quality choices 
 b


 
 
 
 
 
 
 
 
 
 
 Equilibrium ❖ Profit maximization yields following: 
 b (7a) c * ( λ ) = p I * ( λ ) = λ 3 b (7b) φ * ( λ ) = λ 3 (7c) q * ( λ ) = λ b σ ⎛ ⎞ 2 b 3 − a * ( λ ) = ⎟ λ ⎜ (7d) p O ⎝ ⎠ σ − 1 σ ⎛ ⎞ 2 b 3 − a * ( λ ) = ⎟ τλ ⎜ p O , X ⎝ ⎠ σ − 1 σ − 1 ) σ − 1 ⎛ ⎞ ⎡ ⎤ ( ) b ( λ η XP σ , η ≡ σ − 1 (7e) r * ( λ ) = 1 + Z τ 1 − σ 3 + a ⎜ ⎟ ⎢ ⎥ ⎝ ⎠ σ ⎣ ⎦


 
 
 
 
 
 
 
 Comparative Statics ❖ Comparative statics regarding effects of parameters on firm size and final good quality choice 
 ( ) Z τ − σ ( ) Z τ − σ (8a) ∂ ln r * = 1 − σ 2 < 0, and ∂ ln q * = b 1 − σ 2 < 0 ( ) ( ) ∂ τ ∂ τ 1 + Z τ 1 − σ η 1 + Z τ 1 − σ ( ) = σ − 1 (8b) ∂ ln r * ln λ > 0, and ∂ ln q * = ln λ > 0 ∂ b ∂ b 3 b (8c) c * ( λ ) = φ * ( λ ) = λ 3

Comparative Statics ❖ Comparative statics imply: ❖ Firms’ size (i.e., revenue) and the quality choice of final good increase with falling trade costs ❖ A firm that is better able to translate capability into quality produces higher-quality goods and is larger ❖ Trade costs negatively impact quality choice

Comparative Statics

Comparative Statics ❖ Comparative statics examining impact of trade liberalization and ability to translate capability on export entry cutoff point k − η ( ) − η ( ) k 1 − σ ⎛ ⎞ ∂ ln τ = k 1 − σ (11a) ∂ ln λ * f η η f λ m τ η < 0 ⎜ ⎟ ( ) η δ f e k − η ⎝ ⎠ f x 1 σ − η − 1 (11b) ∂ ln λ x ∂ ln τ = σ − 1 ⎛ ⎞ * η f x λ * τ η > 0 ⎜ ⎟ ⎝ ⎠ η f ❖ (11) states falling trade costs induce most productive non-exporting firms to enter export market, and least productive firms forced out of market, as exporting firms now capture larger market share ❖ Classic heterogenous-firms result (see Melitz, 2003)

Comparative Statics ❖ Comparative statics examining impact of trade liberalization and ability to translate capability on market entry cutoff point ⎡ ⎤ ⎛ k − η ⎞ k ⎛ ⎞ ⎛ ⎞ ⎛ ⎞ ⎛ ⎞ − k η η ⎢ f f ⎥ f ( ) ln τ ⎜ ⎟ ⎟ − σ − 1 Λ − ρ + τ 3 a + b ln ⎜ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎢ ⎥ − k ⎝ ⎠ ⎝ ⎠ ⎝ ⎠ ⎜ ⎟ ⎝ ⎠ f X f X f X ⎝ ⎠ ⎛ ⎞ (12a) ∂ λ * λ m f ⎢ ⎥ b ⎣ ⎦ 3 + a ∂ b = 3 k τ ⎜ ⎟ δ f e ρ Λ 2 ⎝ ⎠ ⎡ ⎤ 1 σ − 1 ⎛ ⎞ ⎛ ⎞ ⎛ ⎞ (12b) ∂ λ x ∂ b = − λ * σ − 1 * η f f ⎢ ⎥ ( ) ln τ τ η ⎟ + σ − 1 ln ⎜ ⎟ ⎜ ⎜ ⎟ ⎢ ⎥ 3 η 2 ⎝ ⎠ ⎝ ⎠ ⎝ ⎠ f X f X ⎣ ⎦ ⎛ ⎞ f ( ) , Λ = 3 η − k ( ) ρ = ⎟ 3 a + b ⎜ ⎝ ⎠ f X ❖ These results are ambiguous in sign, due to other parameters

Comparative Statics ❖ (12a) is dependent on this condition: (13a) ∂ λ * ∂ b < 0 when k < η + γ , and vice versa ⎛ ⎞ ⎛ η − k ⎞ ⎛ ⎞ ⎛ ⎞ − k ⎛ ⎞ η η f f ( ) ln τ ⎜ ⎟ ⎜ ⎟ γ = − 1 + τ ⎟ − σ − 1 ⎟ > 0 3 a + b ln ⎜ ⎟ ⎜ ⎜ ⎟ σ − 1 ⎜ ⎝ ⎠ ⎝ ⎠ ⎜ ⎟ ⎝ ⎠ f X f X ⎝ ⎠ ⎝ ⎠ ❖ The impact of depends on shape of the distribution of b firms, , i.e., market structure k

Comparative Statics

Comparative Statics ❖ (12b) is dependent on this condition: ⎛ ⎞ (13b) ∂ λ X * f ( ) ln τ > 0, and vice versa ∂ b < 0 when ln ⎟ + σ − 1 ⎜ ⎝ ⎠ f X f X > f f → f X ❖ The impact of depends on extent that . If , b then export rents outweigh fixed costs of exporting f X >> f given an increased . If , then fixed costs of b exporting outweigh export rents, leading to export exit.

Data ❖ Source: Chile’s Encuesta Nacional Industrial Anual (ENIA), an unbalanced panel data set. Industry-level tariff rates from TRAINS database (WITS). ❖ Sample years: 2001-2007. ❖ Sample size: 11,196 observations, approximately 1,600 food-processing firms per year in the sample.

Data

Data

Empirical Specifications ❖ Export Entry: ( ) = α + β 1 ⋅ c + β 2 ⋅ φ + γ ⋅ b + δ ⋅Δ τ + µ ⋅ λ + κ ⋅ X + ε (14) Pr Export i , t = 1 Export i , t − 1 = 0 ❖ Market Exit: ❖ Specification forthcoming: depends on how ENIA tracks firm exit ❖ Quality Choice: (15) q = α + β 1 ⋅ c + β 2 ⋅ φ + γ ⋅ b + δ ⋅Δ τ + µ ⋅ λ + κ ⋅ X + ε ❖ Changes in Size: 
 (16) Δ Size = α + β 1 ⋅ c + β 2 ⋅ φ + γ ⋅ b + δ ⋅Δ τ + µ ⋅ λ + κ ⋅ X + ε

Results

Conclusion ❖ Theoretical model adapts heterogenous-firms framework to food industry context ❖ Firms that remain in the market select higher quality and are larger given falling trade costs and increased ability to upgrade quality, and use concurrently higher-quality inputs ❖ Trade liberalization forces the least productive firms out of the market while most productive non-exporters enter the export market ❖ Impact of ability to upgrade quality dependent on the market structure: distribution of firms in the market and structure of fixed costs matter ❖ Empirical analysis currently provides mixed evidence: results cast doubt on quality constraint, but generally support the impact of on firm b characteristics and market structure