Creative destruction and export patterns

Abstract

This paper presents an international trade model based on a market structure with monopolistic competition and age dependent quality and productivity in producing each product variety. Due to innovations new product varieties of a still higher quality enter the market every period rendering old varieties obsolete. For a given technology (variety) production costs decrease after an infant period due to learning. While all firms are assumed to be symmetric in a life-cycle perspective, at a given point in time firms of different ages differ in productivity, firm size, product quality, and export behavior. The model highlights a process of creative destruction, which allows firms to produce in a finite span of periods determined by the intensity of product and process innovations. The model predicts a wide range of export behavior of the individual firm during its life cycle depending on the structure of technological progress and trade costs. These predictions are consistent with empirical evidence on firm's internationalization in a dynamic perspective.

Keywords:

• product innovations
• learning
• creative destruction
• export performance

JEL Classifications:

• F12
• F13

Acknowledgements

We are grateful for valuable comments from two anonymous referees. All remaining errors are our own.

Notes

1. An exit could also be triggered by a cessation of demand due to technical progress. This mechanism is established in Young (1991). In our model demand is isoelastic and, hence, the quantity demanded is always strictly positive.

2. We only analyze market equilibrium in a given year, so in order to simplify our notation, preferences are introduced by an ordinal scaling of utility for consumption of varieties from the three generations.

3. The quality parameter is assumed to be constant. Hallak (2006) suggests a more general specification, as the parameter for the intensity of preference for quality, ϕ, varies positively with real income.

4. In papers by, for example, Fajgelbaum, Grossman, and Helpman (2013) and Jaimovich and Meralla (2012) the elasticity of substitution across differentiated goods is modeled as smaller than across quality varieties of the same good.

5. This is standard in the literature, but the concept ‘firm’ may easily be extended to include more cohorts of varieties over time.

6. The limited potential for costs savings through learning for a given technology is used in, for example, Brezis, Krugman, and Tsiddon (1993) in their analysis of leapfrogging in international competition. In Young (1991), on the other hand, learning happens throughout each firm's lifetime. To simplify, we assume that the cost savings materialize fully after the infant period for any volume of output produced in the infant period above 0. Due to this simplification we can disregard intertemporal cost spillovers when the producer optimizes profit in the individual periods during the firm's life cycle.

7. Notice that equilibrium with three generations does not require the condition that π₁ ≥ f as we assume that production in the infant period is necessary for the productivity improvement in the following periods. The condition (6) that cumulated net profit is non-negative ensures that the firm will produce also in the first period even in the case that operating profit for this period may be insufficient to cover fixed costs.

8. The existence of once-and-for-all sunk trade costs does not complicate the formal analysis of equilibrium essentially if the firm exports in at least one period of its life cycle. What matters in such cases in the formal analysis will be the amount of total sunk cost, i.e. sunk costs associated with the establishment of the firm plus sunk trade costs.

9. Notice that the firm will always supply the domestic market if it finds it profitable to export. In case it only supplies the foreign market, it incurs both recurrent fixed production and trade costs, and the operating profit on the domestic market is positive due the specification of the demand function.

10. We assume that individuals disregard their (latent) preferences for foreign goods that are not imported into the home economy. These goods are actually available in the foreign country, but not imported.