Working Paper: NBER ID: w16313
Authors: Julian Di Giovanni; Andrei A. Levchenko
Abstract: Firm size follows Zipf's Law, a very fat-tailed distribution that implies a few large firms account for a disproportionate share of overall economic activity. This distribution of firm size is crucial for evaluating the welfare impact of economic policies such as barriers to entry or trade liberalization. Using a multi-country model of production and trade calibrated to the observed distribution of firm size, we show that the welfare impact of high entry costs is small. In the sample of the largest 50 economies in the world, a reduction in entry costs all the way to the U.S. level leads to an average increase in welfare of only 3.25%. In addition, when the firm size distribution follows Zipf's Law, the welfare impact of the extensive margin of trade -- newly imported goods -- is negligible. The extensive margin of imports accounts for only about 5.2% of the total gains from a 10% reduction in trade barriers in our model. This is because under Zipf's Law, the large, infra-marginal firms have a far greater welfare impact than the much smaller firms that comprise the extensive margin in these policy experiments. The distribution of firm size matters for these results: in a counterfactual model economy that does not exhibit Zipf's Law the gains from a reduction in fixed entry barriers are an order of magnitude larger, while the gains from a reduction in variable trade costs are an order of magnitude smaller.
Keywords: No keywords provided
JEL Codes: F12; F15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| High entry costs (L11) | Small welfare impact (D69) |
| Reduction in entry costs to US levels (F69) | Increase in welfare (I38) |
| Firm size distribution following Zipf's law (D39) | Small welfare impact from high entry costs (D69) |
| Firm size distribution not following Zipf's law (D39) | Larger gains from reducing fixed entry barriers (L11) |
| Extensive margin of trade (F10) | Small contribution to total welfare gains (D69) |
| Intensive margin of trade (F14) | Large contribution to total welfare gains (D69) |
| Firm size distribution (L25) | Welfare impacts of policy changes regarding entry costs and trade barriers (F69) |