Relation Specificity, MarketThickness, and International
Trade
Tomohiro Ara (Fukushima University)
Taiji Furusawa (Hitotsubashi University)

1

International trade andoffshoring

Volume of international trade has been rising Components trade Offshoring

Has an increase in final goods trade stimulate offshoring, andhence stimulate components trade?

Interaction and feedback effects

 Relation specificity
 Market thickness
 Matching between upstream and downstream firms
 Negotiation within matched pairs on profit sharesQuality of products (or productivity) is affected by suchenvironment21Related literature McLaren (AER 2000)
 Grossman and Helpman (QJE 2002)
 Nunn (QJE 2007)

3Outline Basic model Autarkic equilibrium Relation specificity of industry and marketthickness
 Final-good trade equilibrium Reduction of trade cost and market thickness

 Conclusion
42

Framework
 Two symmetric countries

individuals in each country
 Labor is the only production factor
 Each individual has one unit of labor Labor is the numeraire: Several monopolistically-competitive

industries
 We focus on one industry in this talk Continuous time
5Industry and consumer
preferences A representative industry
 Upstream and downstream sectors

units of labor  1 unit of component D: 1 unit of component  1 unit of the final good U:

 Free entry in both sectors

 A representative consumer’s preferences

63

Relation specific investment
upstream firms and If matched:pairs

downstream firms match Nash bargaining about profit sharing
 Upstream firm invests
 Quality of the final good = 1

 If unmatched U: Sell components in the market (perfect competition)
 D: Buy components in the market
Quality of the good = Degree of relation specificity

7

Matching technology
 Constant-returns-to-scale matching function
 Probability of matching
 D:

where
 U:

 Relationship breaks down at a rate of84Matching in the steady state
Upstream

MatchedDownstream

9Outline Basic model Autarkic equilibrium Relation specificity of industry and marketthickness
 Final-good trade equilibrium Reduction of trade cost and market thickness

 Conclusion
105

Bellman equations
 Downstream firms
 Matched: Unmatched: Upstream firms
 Matched: Unmatched:

11

Steady state value functions
 Downstream firms
 Matched: Unmatched: Upstream firms
 Matched: Unmatched:126

Nash bargaining Problem

 Payoffs

 Profits from the final good market

13

Value functions
 Value functions,, can be
written as functions of and Value functions of unmatched firms


14

7

Free entry conditions
 Downstream sector

 Upstream sector

15

Equilibrium

168Market thickness
 Total outputs of components

 Market thickness
 Components traded in the market relative to components

traded directly inside pairs Number of unmatched upstream firms relative to that ofunmatched downstream firms

17

Relation specificity and market
thickness The higher the relation specificity
 the lower the market thickness
 the more favorable to downstream firms inmatching

but
18

9

Outline Basic model Autarkic equilibrium Relation specificity of industry and market

thickness Final-good trade equilibrium Reduction of trade cost and market thickness

 Conclusion
19

Trade costs and trade pattern Trade costs
 Fixed costs:
 Variable iceberg costs:

 Fixed costs  Only matched downstream

firms export

2010Free entry conditions
 Downstream sector

 Upstream sector

21Equilibrium

2211

Reduction of trade costs andmarket thickness This effect is large,

the larger is

23

Outline Basic model Autarkic equilibrium Relation specificity of industry and marketthickness
 Final-good trade equilibrium Reduction of trade cost and market thickness

 Conclusion
2412

Preliminary conclusion
 Trade affects market thickness; size of theeffect varies with relation specificity ofcomponent traded in the industry Extension
 Offshoring2513