Globalization drives strategic product switching

Abstract

Using firm-level panel data for Estonia, we analyse the impact of international competition on firm dynamics, considering both firm closedown and product switches. We contribute to the literature in two important ways: first, this is the first paper to study the determinants of exit and product switching in an emerging market; and second, we consider explicitly the role of export opportunities. Our results indicate that globalization does not affect firm exit significantly but it is an important factor explaining why firms choose a different core product. Previous studies on industrial countries have shown that product switching has been a defensive strategy against low-cost imports. In contrast, our results suggest that Estonian firms change their core products as an offensive strategy to take advantage of the export opportunities created by a globalized economy.

Appendix: definitions of variables

The firm-level data used in this paper are provided by the Estonian Business Registry and cover the period 1997–2005. The trade data are from the UN Comtrade (commodity trade statistics) database and consist of the trade values and quantities of import flows at the six-digit product level, according to the Harmonized System (HS) classification 1988/92. See Moreno Badia et al. (2008) for details about the data cleaning process.

1.1 Firm-level variables

All monetary variables are expressed in real terms. Output and intermediate input deflators, as well as the gross capital formation price index, were obtained from the Statistical Office of Estonia. Deflators are available for 16 sectors corresponding to the International Standards Industrial Classification (ISIC Rev.3.1) at the one-digit level.

Exit _it+1 :

Dummy variable, equal to 1 in period t if the firm exits in period t+1. Firm exit is defined based on the official date of liquidation from the Commercial Register. If a firm disappears from the data set and has an official liquidation date, it is considered to exit in the last year of observation. Liquidation due to a merger, acquisition or re-registration in the registry is not considered an exit.

Switch _2d,it+1 :

Dummy variable, equal to 1 in period t if the firm switches two-digit NACE industries in period t+1. An industry switch is defined as a change in the firm’s primary sector of activity. Firms in Estonia are asked only about their primary sector of activity. This implies that, if a firm reports a particular industry/product code in 1 year and a different code in the next, it has changed its main sector of activity.

Switch _4d,it+1 :

Dummy variable, equal to 1 in period t if the firm changes four-digit NACE products in period t+1. A product switch is defined as a change in the firm’s main product line.

Age _it :

Age of the firm in period t, defined as the number of years the firm has been in the registry (using the registry entry date).

Size _it :

Firm size, measured by the number of employees in period t.

Wage _it :

Average real labour costs, defined as total firm-level labour costs divided by the number of employees.

Capital _it :

Capital intensity, measured as real capital per employee. Capital is defined as the sum of tangible and intangible assets, net of goodwill at the firm level.

TFP _it :

Total factor productivity at the firm level, estimated at the two-digit industry level using the methodology of Levinsohn and Petrin (2003) while taking into account industry switches over time. For a detailed description of the methodology employed to estimate TFP using the current data set, we refer to Moreno Badia and Slootmaekers (2009).

Foreign _it :

Foreign ownership dummy, equal to 1 if at least 50% of the firm’s shares are foreign owned.

1.2 Product-level variables

All product-level variables are defined at the four-digit NACE level.

Sunk _jt :

Sunk costs variable, defined as the natural logarithm of the median of real sales in each particular four-digit industry j at time t.¹³

Herf _jt :

Herfindahl–Hirschman index for the domestic market, defined as the sum of squared market shares. Market shares are defined as firm-level real sales over product-level total real sales. It ranges from 0 to 1 as it moves from a very large amount of very small firms to a single monopolistic producer.

Imports _jt :

Total imports of product j at time t, measured in Estonian krooni (EEK).

IIT _jt :

Intra-industry trade variable, defined as the Grubel–Lloyd index, that is, $\left\lfloor {1 - \left( {{{\left| {X_{jt} - M_{jt} } \right|} \mathord{\left/ {\vphantom {{\left| {X_{jt} - M_{jt} } \right|} {\left( {X_{jt} + M_{jt} } \right)}}} \right. \kern-\nulldelimiterspace} {\left( {X_{jt} + M_{jt} } \right)}}} \right)} \right\rfloor$, where X _jt and M _jt are respectively exports and imports of product j at time t.

CA _jt :

Revealed comparative advantage dummy, equal to 1 if X _jt  > M _jt , i.e. if exports are larger than imports for product j at time t.

Exports _jt :

Total exports of product j at time t, measured in Estonian krooni (EEK).

Herfex _jt :

The Herfindahl–Hirschman index for the export market is calculated at the Harmonized System (HS) six-digit level. Conversion to NACE Rev. 1.1. at the four-digit level is achieved using a concordance table provided by Eurostat. We define a market as a pair consisting of a geographic destination and a product. We calculate the index of concentration in market m as.

$$ H_{m,t}^{j} = \sum\limits_{\forall Exporter} {s_{n,t}^{2} }, $$

where $\mathop s\nolimits_{n,t},$ is the market share of exporter n in market m at period t. Aggregating across all export markets for product j we obtain the overall index of market concentration for exports of product j:

$$ Herfex_{jt} = \sum\limits_{\forall m} {H_{m,t}^{j} *\beta_{m,t}^{j} } $$

where $\mathop \beta \nolimits_{m,t}^{j}$ is the share of market m in total exports of product j in period t.

UVR _jt :

Average relative unit values index for Estonian export products, taking into account Estonia’s main competitors. In particular, we compute the unit value for product j in market p by dividing the export value of each exporter by the export quantity. Relative unit values for product j in market p are then calculated dividing the unit value of Estonia by the weighted average of the unit values of its competitors in that market. The overall relative unit value for product j is the weighted sum of the relative unit values across all markets, with weights equal to export shares.