Learning about demand abroad from wholesalers
How do firms become exporters? Using transaction-level data from Belgium, this column examines the role of intermediary firms in the internationalisation process. It finds that a manufacturing firm that exports indirectly to a particular destination via a wholesaler is more likely to go on to become a direct exporter to that destination at a later point. This effect is driven by the spillover over of knowledge on foreign demand from the wholesaler to the manufacturer. The role of intermediaries is particularly important for destination markets that are further afield, where firms face greater uncertainty.
How do firms become exporters? Early studies analysing the internationalisation strategies of firms focused on common firm characteristics that make domestic firms successful exporters (Melitz 2003, Bernard et al. 2003). An important aspect which was not addressed in these early studies is the role of trade intermediaries. Understanding the role of intermediary firms is particularly useful when designing policy aimed at helping firms to achieve the threshold for exporting. Given the benefits in terms of productivity and revenues experienced by firms after they start to export to foreign markets, it is important to understand the process that precedes a firm’s decision to become a direct exporter (Van Biesebroeck 2005, De Loecker 2007, Bai et al. 2017, Atkin et al. 2017).
Recent access to novel business-to-business (B2B) transaction-level datasets can offer additional insights into the dynamic process of how domestic firms become direct exporters. In this column, we report the findings of our recent study of business connections between firms in Belgium (Connell et al. 2019). From our research, it becomes clear that exporting indirectly through the sale of goods to a wholesaler, which then exports these goods, acts as a stepping stone to becoming a direct exporter in later years. We find that a firm is more likely to become a direct exporter to a particular destination if it previously had a connection with a wholesaler exporting to the same destination. These findings shed significant new light on the internationalisation process of firms. They show that intermediary wholesalers help a firm to learn about the demand for its product abroad, thus reducing uncertainty and, if demand is strong, raising the expected profits from direct exporting. Trading intermediaries thus offer a hitherto unexplored channel for information spillovers to manufacturing firms. The challenge in the research is in separating the demand spillover from productivity spillovers between manufacturing firms and wholesalers.
The importance of intermediary firms as part of the internationalisation strategies of manufacturing firms can be easily observed by looking at data. While the share of firms serving foreign markets through direct exports may be relatively small, the share of firms that are connected to an exporting firm, and consequently engaging in indirect exports, tends to be much higher. In the case of Belgium, Dhyne et al. (2015) observed that while only 5% of the population of firms were exporting directly in 2014, the share of firms that exported indirectly through the supply networks of exporting firms was 82%. This difference can be partly explained by the role of wholesalers, given their importance in facilitating international flows. In 2014, one third of the total number of Belgian exporting firms were pure wholesalers, representing around 40% of total exports in value terms. Recent studies have identified the use of wholesalers by manufacturing firms as an internationalisation strategy followed by relatively low-productivity firms (Crozet et al. 2013, Bernard et al. 2015, Akerman 2018). The traditional explanation given for this is based on the idea that wholesalers reduce the fixed costs associated with exporting activities for manufacturing firms. However, this does not take into account the dynamic effects originating from these business connections.
We put forward a new, complementary reason for why manufacturing firms might engage in indirect exporting via wholesalers. In addition to cost savings, wholesalers provide a channel for learning about specific demand in a foreign country that helps manufacturing firms to become direct exporters in the future. We use a unique B2B transaction-level dataset that, for the first time, allows us to establish firm links between buyers and sellers within the Belgian domestic market. Using this dataset, we can provide new answers to two questions: How do firms become direct exporters? And what does the nature of business connections tell us about the probability of firms becoming direct exporters?
Our main finding is that foreign exposure via an exporting wholesaler increases the probability of becoming a direct exporter to a particular destination in subsequent years. Specifically, we show that non-exporting firms with a previous connection to an exporting wholesaler are over six times more likely to engage in direct exports in the subsequent time period than a comparable manufacturing firm without previous foreign exposure. This finding can be explained by the idea that a wholesaler selling a good to a particular destination will initially have more information about local demand in that destination than the non-exporting manufacturing firm using the wholesaler. Through its contacts with the wholesaler, the manufacturing supplier will gradually learn more about the strength of demand for its products in the foreign market. Based on these findings, we conclude that the use of a wholesaler can be an intermediary step that helps firms reach the status of direct exporter. This result is not driven by productivity spillovers but by learning about the demand side, which reduces demand uncertainty and consequently increases the participation of firms in foreign markets. We also show, as expected, that the importance of wholesalers for the future export status of non-exporting firms is stronger for destination markets located geographically further away, where the uncertainty faced by domestic firms is greater.
Given the importance for open economies of domestic firms becoming successful exporters, and based on the finding that well-functioning domestic networks increase the participation of firms in foreign markets, policy aimed at helping firms to achieve the export threshold should consider measures to improve the understanding and functioning of domestic networks.
Authors’ note: We write in our personal capacity and the expressed opinions should not be attributed to any institution with which one of the authors is affiliated.
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