Trade Adjustment Costs in Developing Countries: - World Bank ...

288James Tyboutsimple sunk cost model. In particular it explains why (1) many exporters shipsmall amounts and then exit the destination market, (2) sellers who start withlarger export volumes are more likely to remain in the export market, and (3) onaverage, the successful members of each cohort experience rapid export growthafter their first year. However, the Rauch–Watson idea has some limitations. Ittreats suppliers as passive agents who do not search for buyers, and it does notaccount for the fact that buyers use multiple suppliers.Arkolakis (2008a; 2008b) shifts the search process from buyers to sellers in hisinterpretation of the stylized facts mentioned above. More precisely, he arguesthat exporters can easily find a few customers in a destination market, but afterthe low-hanging fruit has been picked they must ferret out after increasinglyhard-to-find buyers. Thus the costs of building a clientele rise more than proportionatelywith export sales. This characterization of marketing costs meansthat non-exporting firms who experience favorable productivity shocks shouldfind it easy to establish a toehold in foreign markets, counter to the standardsunk cost specification. But the more market inroads these new exporters make,the tougher shedding becomes, and the more their growth rates slow down. Byassuming that exporters’ productivity shocks follow a Brownian motion, Arkolakis(date) is able to explain the large volume of short-lived, small-scale exportingepisodes, the surge in shipments among a small set of successful newexporters, and the growth slowdown as firms’ exporting relationships mature.Eaton et al. (2009) also develop a model in which sellers search for buyers, butthey add seller-side learning. As in Arkolakis’s models, costs are convex in searchintensity. However, each time an exporter meets a buyer, the seller receives anoisy signal about their product’s appeal to consumers in the destination market.A large order from a new buyer signals that the product is likely to be popularwith others, while a small order signals the opposite. Each time a match is madeand a signal is conveyed, the exporter updates their priors concerning the product’sappeal and adjusts their search intensity. Early signals are the most informative,so they result in the largest adjustments in search intensity. Matchesbetween buyers and sellers endure from one period to the next, subject to an exogenoushazard of separation.More formally, Eaton et al. (date) assume that firm j is able to discover new buyersat the rate λ j when it spends c(λ j ) on search activities, and that its existingmatches break up at some exogenous rate. Further, they assume that j’s expectedprofit stream from its next match can be written as, where e t isthe real effective exchange rate, ϕ jt is j’s current productivity, and and arethe mean and standard deviation of the posterior distribution that summarizes j’sbeliefs about its product’s appeal after it has experienced n matches. 5 These beliefsare based on a standard Bayesian updating process which in turn reflects thesize of the orders that have been placed by buyers whom seller j has previously5 The expected profit stream is related to single period export profits by the matchseparation hazard, the Markov processes for exogenous state variables, and the Bayesian updatingrule.