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Firms in the global economy

Gianmarco Ottaviano, Professor of the Achille and Giulia Boroli Chair in European Studies at Bocconi University, holds an Advanced Grant from the European Research Council (ERC).


From Micro to Macro: Aggregate implications of firm-level heterogeneity in international trade.


What determines the effect of international trade on welfare? Can individual incentives to trade diverge from societal objectives? Should governments intervene to promote or restrict international transactions? Questions like these have recently gained new salience, due to renewed protectionist pressures and resurgent nationalistic tendencies arising from diffuse disenchantment with globalization. The aim of the research project is to highlight key dimensions along which the answers to these questions obtained from conventional trade models with homogeneous firms should be revisited in the light of permanent pervasive firm heterogeneity. In particular, the project will pursue four specific objectives through four integrated work packages providing new insights on how firm heterogeneity affects: (1) The ability of markets to deliver allocative efficiency; (2) The design of optimal multilateral trade policies; (3) The comparative advantages of countries; (4) The capabilities of a country as an exporter.

Work packages

  1. Market Size, Competition and Misallocation of Resources

    In the “canonical” economic models based on a demand system featuring constant elasticity to price, trade liberalization leads to a more efficient allocation of productive resources thanks to specialization according to comparative advantage. Typically, within this framework, there is no room for welfare to improve policy intervention: free trade is the best multilateral trade policy. When economic transactions are observed to deviate from such a scenario, should we expect the same policy conclusion?

    RESEARCH OBJECTIVES. This work package will investigate whether the allocative inefficiency determined by firm heterogeneity in the presence of pricing distortions is quantitatively relevant for a country’s aggregate economic performance, and whether economic integration reduces or exacerbates misallocation.

  2. Geography, Competition and Multilateral Trade Policy

    RESEARCH QUESTIONS. How should multilateral trade policy be designed in a world in which countries differ in terms of market access and technology, and firms with market power differ in terms of productivity? Should trade policy differ across countries? Should worse performing (national) firms be protected from better performing (foreign) rivals? Should national product diversity be shielded against the potentially disruptive effects of cheaper imported goods?
    RESEARCH OBJECTIVES. This work package will develop the implications of firm heterogeneity for trade policy in the presence of markup distortions, with special emphasis on the cooperative design of optimal multilateral trade agreements aimed at maximizing the joint welfare of all trade partners.

  3. Competition, Reallocation and Comparative Advantage

    RESEARCH QUESTIONS. How do country, sector and firm characteristics interact to determine countries’ responses to trade liberalization? In traditional trade theories differences in the relative state of technology across sectors between countries (Ricardian model) or in the relative factor abundance of countries when sectors have different relative factor intensities (Heckscher-Ohlin model) give rise to “ex ante” comparative advantage and gains from trade. Taking into account firm heterogeneity, country and sector characteristics should interact with firm characteristics to determine the effects of a trade liberalization. Despite the importance of this insight, we know very little about its implications on welfare. In particular, a potentially relevant part of the story has been so far overlooked: reallocations taking place at the “intensive margin” between incumbent firms. 

    RESEARCH OBJECTIVES. This work package will foster the understanding of how country, sector and firm characteristics interact to determine countries’ responses to trade liberalization. The resulting theory will feature comparative advantage, heterogeneous firms and variable markups. The conjecture is that in a country’s industries of ex ante comparative disadvantage, firms will be more likely to face tougher competition abroad than at home. In these circumstances trade liberalization generates forces dampening ex ante comparative advantage.

  4. Firm Productivity Distribution and Aggregate Exports

    RESEARCH QUESTIONS. What determines the ability of a country to export in a given sector? Traditional trade theories highlight the country’s comparative advantage due to relatively better technology than its trading partners or relative abundance of factors intensively used in the sector. New trade theories emphasize the role of larger size of the domestic market in the presence of technologies with returns to scale at the firm level. Beside these two forces, recent evidence suggests that the success of a country in exporting shall be related to the distribution of efficiency levels among the top local producers.

    RESEARCH OBJECTIVES. This work package will show that firm heterogeneity plays its own distinct role in determining a country’s capabilities as an exporter through the shape of the productivity distribution of its producers. In addition, we will show how the dispersion of productivity among top-performing producers can play a key role in explaining both the level and the response to trade liberalization of resource misallocation.