The Comparative Advantage of Firms

Johannes Boehm (1, 2) , Swati Dhingra (2) , John Morrow (3)

1 ECON - Département d'économie (Sciences Po)
2 CEP - LSE - Centre for Economic Performance
3 King‘s College London

Multiproduct firms dominate production, and their product turnover contributes substantially to aggregate growth. Theories propose that multiproduct firms grow by diversifying into products which need the same know-how or capabilities, but are less clear on what these capabilities are. Input output tables show firms co-produce in industries that share intermediate inputs, suggesting input capabilities drive multiproduct production patterns. We provide evidence for this in Indian manufacturing: the similarity of a firm’s input mix to an industry’s input mix predicts entry into that industry. We identify the direction of causality from the removal of size-based entry barriers in input markets which made firms more likely to enter industries that were similar in input use to their initial input mix. We rationalize this finding with a model of industry choice and economies of scope to estimate the importance of input capabilities in determining comparative advantage. Complementarities driven by input capabilities make a firm on average 5% (and up to 15%) more likely to produce in an industry. Entry barriers in input markets constrained the comparative advantage of firms and were equivalent to a 10.5 percentage point tariff on inputs.

Keywords: Multiproduct firms; Firm capabilities; Vertical input linkages; Comparative advantage; Economies of scope; Size-based policies

Domains: Humanities and Social Sciences; Economics and Finance

Johannes Boehm, Swati Dhingra, John Morrow. The Comparative Advantage of Firms. 2019. ⟨hal-03606252⟩