Sunk costs hysteresis in Spanish manufacturing exports

Transcription

1 Sunk costs hysteresis in Spanish manufacturing exports Juan A. Máñez Castillejo María E. Rochina Barrachina Juan A. Sanchis Llopis Universidad de Valencia and LINEEX April-2005 Corresponding author: Juan A. Máñez-Castillejo Universidad de Valencia Facultad de Economía Departamento de Economía Aplicada II Avda. de los Naranjos s/n Valencia (Spain) Phone: Fax: Acknowledgements: Financial support from the Instuto Valenciano de Investigaciones Económicas and the Ministerio de Ciencia y Tecnología (SEC ) is gratefully acknowledged. We would also like to thank Fundación SEPI for providing the data.

2 Sunk costs hysteresis in Spanish manufacturing exports Abstract This paper tests the sunk costs explanation for hysteresis in exports using a sample of Spanish manufacturing firms for the period , allowing for sunk costs to be different for small and large firms. The data are drawn from the Spanish Encuesta sobre Estrategias Empresariales. To obtain consistent estimates for sunk costs, we control for all other sources of persistence and use a dynamic random effects multivariate prob model that is estimated through pseudo simulated maximum-likelihood techniques. Our results support the sunk costs explanation for hysteresis for both size groups and indicate that sunk costs are smaller for large firms. Furthermore, some firm characteristics such as size, productivy or vertical and horizontal product differentiation are found to have a significant influence on the probabily of exporting. Key words: hysteresis in trade, sunk costs, firm size, dynamic discrete choice models JEL classification: F12, L1, C23, C25 1

3 1. Introduction. In the analysis of the decision to export seems sensible to think that firms face costs associated wh entering foreign markets that may be sunk in nature. For instance, non-exporting firms have to research foreign demand and competion, establish marketing and distribution channels, adjust their product characteristics and packaging to meet foreign tastes and/or fulfil qualy and secury legislation of other countries. Acknowledging the existence of sunk costs implies that current exports depend on past export trajectories and, more interestingly, that transory changes in trade policy or condions may lead to permanent changes in market structure, that is, sunk entry or ex costs produce hysteresis in export flows. 1 Furthermore, when there is uncertainty about market condions, the existence of sunk costs affects the entry and ex patterns as trade flows are less responsive to changes in market condions, such as exchange rates or incentives (subsidies) for exports. It is important to note that although persistence in exporting status might be caused by sunk costs, might also be due to eher underlying (observed and unobserved) firm heterogeney or serial correlation in transory shocks to exporting profs. Therefore, in order to identify the role of sunk costs one would need an econometric framework that allows controlling for all competing sources of persistence in export behaviour. The first attempt to tackle the sunk-cost hysteresis hypothesis in the empirical lerature on exporting is Roberts and Tybout (1997), who directly analyse entry and ex patterns using plant-level panel data for Colombian manufacturing. More recent empirical evidence on sunk costs hysteresis are Bernard and Wagner (1998), Bernard and Jensen (2004) and Campa (2004), for German plants, U.S. plants and Spanish firms, respectively. The objective of this paper is to assess the importance of sunk costs hysteresis examining the decision of firm export participation and to test whether 1 The theoretical lerature on sunk costs and exporting was developed by Dix (1989a,b), Baldwin (1988), Baldwin (1989), Baldwin and Krugman (1989) and Krugman (1989). 2

4 sunk costs differ between large and small firms, using panel data for Spanish manufacturing firms, drawn from the Encuesta sobre Estrategias Empresariales (hereafter, ESEE), for the 1990s. To account for different causes of persistence we implement a dynamic random effects multivariate prob model, which is estimated by simulated maximum likelihood techniques. The main contributions of our work to the existing lerature are the following. First, we use an extensive set of firm specific and market characteristics to account for observed firm/market heterogeney, paying special attention to vertical and horizontal product differentiation, and spillovers. Secondly, whereas previous works impose a structure on the serial correlation of transory shocks (Roberts and Tybout, 1997, Bernard and Wagner, 1998, and Bernard and Jensen, 2004), we allow for a free serial correlation. Misspecification problems may arise from a given structure and may lead to inconsistent estimates for sunk costs. Thirdly, different to other empirical studies using plant data (Roberts and Tybout, 1997, Bernard and Wagner, 1998, and Bernard and Jensen, 2004), we have firm data, which are the observation uns appropriate for modelling the export decision. Finally, a novelty in the existing lerature is that we allow the coefficients controlling for sunk costs to differ between small and large firms. If some unobserved characteristics determining sunk costs of entering export markets are linked to the size group to which the firm belongs, we expect sunk costs to vary between size groups. For example, other things being equal, if large firms have advantages in establishing international networks, acquiring information, they benef from organizational advantages, or they enjoy economies of scope in exports they should face smaller sunk costs. As in Campa (2004) we also analyse the decision to export by Spanish firms. However, our work differs from Campa s (2004) in the following respects. First, when modelling the export decision Campa (2004) considers a limed set of firm and market characteristics. By widening this set, identification of sunk costs is improved. 2 Secondly, Campa s (2004) estimation method does not allow for serial correlation in transory shocks. As such, this unmodeled persistence in the 2 As specifically stated by Campa (2004), his paper does not focus on the characteristics of the firms that enter or ex the export market. His main focus is the responsiveness of Spanish export supply to changes in the exchange rate. 3

5 error structure may have been picked up by the variables capturing past exporting trajectories and thus incorrectly interpreted as sunk costs. However, our estimation method allows for this serial correlation. Thirdly, whereas our work considers data from 1990 to 2000, the sample period in Campa (2004) only covers until Finally, Campa s (2004) restriction about sunk costs being independent of the firm s history prior to the previous year prevents him from examining the speed of depreciation of the exporting experience. Our analysis, by allowing sunk costs to be a function of a longer exporting history and to differ between size groups, improves the understanding of the dynamics of participation in foreign markets. Our results suggest that, even after controlling for unobserved firm heterogeney and serial correlation in transory shocks, sunk costs and observed firm heterogeney are important determinants of the export decision. Hence, we find evidence to support the sunk costs explanation of the hysteresis hypothesis. Our results also indicate that large firms have smaller sunk costs than small firms, but both size groups share a rapid depreciation of their exporting experience if they leave the export market. Furthermore, we find that firms which are larger, more productive and have higher R&D and advertising intensies enjoy a higher probabily of exporting. These findings contribute to better understand the determinants of the firm s decision to export and suggest possible export promotion policies. On the one hand, policies oriented to improve information and access to foreign markets by providing exporting infrastructures could reduce the sunk costs of entry, which are especially relevant for small firms. On the other hand, policies directed at increasing productivy or stimulating product differentiation behaviours would have a posive impact on exporting. The rest of the paper is organised as follows. In section 2 we present the data and analyse export patterns for Spanish manufacturing. Section 3 is devoted to modelling, estimation issues and variables. The estimation results are summarised in section 4. Finally, section 5 concludes. 4

6 2. Data and export patterns The data. We use data drawn from the ESEE, a representative annual survey of Spanish manufacturing firms carried out since 1990, which includes exhaustive information at the firm level. The sampling procedure of the ESEE is the following. In the base year, 1990, firms were chosen using a selective sampling scheme wh different participation rates depending on firm size. All firms wh more than 200 employees (large firms) were requested to participate and the participation rate reached approximately 70% of the number of firms in the population. Firms that employed between 10 to 200 (small firms) were randomly sampled by industry and size strata, holding around 5% of the population. 3 Hence, the coverage of the dataset is different depending on the size group of firms. The different sampling properties of these two size groups as well as the possible relationship between size and the export decision advice to carry out a separate analysis of the representativeness of the sample and export patterns by size group. We select a panel of continuously operating firms over the period The choice of a continuous panel is motivated by two reasons. First, to analyse firm s export trajectories for the maximum length of time, we sample out those firms that fail to supply export information in any year. Second, to estimate a dynamic specification wh lagged endogenous variables, we need to build up a panel as long as possible. Furthermore, we drop any firm that failed during the sampling period. 4 After applying these creria, we end up wh a balanced panel of 755 firms. 3 Firms wh less than 10 employees in 1990 were not included in the survey. 4 Including these firms would involve to model the probabily of failing and would substantially complicate the analysis. However, this assumption is not innocuous, as shown in Esteve, Sanchis and Sanchis (2004), where using a sample drawn from the ESEE, they find that exporting firms are less likely to fail. 5

7 Table 1 shows that, in our sample, small firms are slightly overrepresented when compared to the complete sample: in 1990, their proportion in total firms and their shares in total employment, sales and exports are larger. [Insert Table 1 about here] Table 2 shows that, regardless of size group, firms in our sample are smaller (as measured by the number of employees) and export a higher proportion of their sales than firms in the complete sample. However, other relevant characteristics such as the sample probabily of being an exporter/nonexporter or the share of exporting firms on total sales and employment are similar in both samples. We therefore consider that our sample is suable to estimate the probabily of exporting. [Insert Table 2 about here] Table 3 reports characteristics of our sample on export activy, by size group, for the period The proportion of exporting firms steadily increased for both groups along the period (for small firms rose from 33.83% to 52.50% and for large firms from 84.33% to 94.36%), although such proportion always remained higher for large firms. This could be suggesting that sunk costs of entering the export markets are smaller for large firms. At the same time, the participation of exports on sales grew much faster for large firms than for small ones. This is explained by two factors: first, the annual growth rate of exports is larger for large firms than for small ones (11.95% and 10.34%, respectively) and secondly, the annual growth rate of sales is larger for small firms than for large ones (5.63% and 5.10%, respectively). Hence, whilst the fraction of exports on sales for large firms is under 1.5 times that for small firms (21.37% and 15.08%, respectively) in 1990, is almost double (42.39% and 24.16%, respectively) by [Insert Table 3 about here] 6

8 2.2. Entry and ex patterns in the export market. To evaluate the importance of the flows in and out of the export market, we analyze sample transion rates (Table 4). 5 Each one of the entries in this table gives the proportion of firms in each of the year-t statuses (export versus non export) that choose each of the two possible statuses in year t + 1. The second and third rows of each panel of Table 4, which report the entry and ex rates in/from the export market (i.e., transions from no exports to exports and from exports to no exports), show that exporting one year does not necessarily mean permanence in this activy. For the group of small firms, the average entry and ex rates are que similar (8.4% and 7%, respectively) and some years the ex rate exceeds the entry rate, suggesting a high rate of turnover. For large firms, the average entry rate is above 18% and the ex rate under 2%, pointing out a clear trend of incorporation to the export market and of persistence in that status. Hence, is very likely that once a large firm starts exporting remains doing so. As a result of these entry and ex rates, there is a net gain of 113 exporters (99 out of the 356 non-exporters classified as small in 1990 and 14 out of the 34 non-exporters classified as large, see Table 3). In population terms, this means a net gain of 2000 firms (1980 small and 20 large), suggesting that export became a general activy during the analyzed period. 6 [Insert Table 4 about here] Together wh the substantial entry and ex, there is an important degree of persistence in the exporting status: 63.01% of small firms and 77.41% of large firms never change their exporting status. 7 Columns 1 and 2 of Table 5 present the proportion of exporters and non-exporters in 1990 that had the same status in one of the subsequent 10 years. 8 The percentage of small firms that exported in 5 For the purpose of calculating transion rates, firms have been spl into size groups according to their employment in The alternative of using current employment could lead to transion rates higher than 100%, since a number of firms move from the small to the large group and viceversa over time. 6 These figures have been calculated taking into account the sampling scheme of the ESEE. 7 These figures have been calculated accounting for the firms that always or never export. 8 We follow Bernard and Jensen (2004) to build up this table. In these columns we do not distinguish between firms that export (not export) continuously and firms that change status. For 7

9 1990 and were also exporting in 1995 is slightly above 90% (five years later this percentage is exactly the same). For large firms persistence is even more intense as 94% of the firms exporting in 1990 also exported in 1995 and five years later this percentage is even larger, 95.6%. Persistence in the non-exporting status, though important, is not as intense as in the exporting status. Almost 77% of small firms that did not export in 1990 did not export five years later, and 67.1% did not export in Among large firms, persistence in the non-exporting status is even lower as the aforementioned percentages get reduced to almost 53% and 35.3%, respectively. This lower rate of persistence for large firms in the non-exporting status confirms the trend of incorporation to the export market detected above. [Insert Table 5 about here] Columns 3 and 4 of Table 5 report the predicted rates of persistence in each of the two statuses. These are calculated using the annual transion rates given by the data and presented in Table 4. Regardless of size group, and over the whole sampling period, predicted persistence is lower than (sample) actual persistence. Hence, we can extract two conclusions: first, the probabily of exporting is higher for firms that have exported before, i.e. there is a high rate of re-entry by former exporters; secondly, firms in the export market wh a nonexporting past have a higher probabily of leaving the export market. We observe higher (lower) persistence rates in exporting (non-exporting) status for large firms than for small firms. So far we have detected that export participation shows a high level of persistence across firms in the sample by size group. Now, we analyze if there exists heterogeney of entry and ex rates across industries. Figure 1 shows average annual firm entry and ex rates for the 20 manufacturing sectors of the NACE-93 classification and the overall sample of firms. 9 While some industries exhib turnover patterns that are similar to the overall sample, other industries (such as leather and shoes, printing and printing stuff, rubber and plastic products, metallurgy, office machines, motors and cars, other transport example, in the percentage of 1996 we include both firms that exported every year from 1990 to 1996 and firms that exported in 1990 and 1996, but not in one or more of the years in between. 9 The industry classification can be found in at the bottom of Table 6. 8

10 materials, furnure or other manufacturing goods) show entry or ex rates that substantially differ from those of the overall sample. 10 This suggests that firm/market characteristics are likely to be important determinants of the export decision. [Insert Figure 1 about here] The aim of next section is to present an econometric model to investigate the role of sunk costs and firm and industry characteristics in explaining observed exporting status persistence. Furthermore, the observed differences between the patterns of persistence for large and small firms suggest to check whether sunk costs differ between the two size groups. 3. Modelling and estimation Modelling the export decision. We follow Roberts and Tybout (1997) in modelling the decision to export by a rational, prof-maximizing firm. The firm considers expected profs (net of entry and ex sunk costs) derived from that decision. In each period t the variation in gross profs adjusted for sunk costs is given by 0 j 0 ( ) ( ) J i ˆ π = π % y pt, s F (1 yi, t 1 ) F F yi, t j Gyi, t 1(1 y ) (1) j = 2 where y takes the value of 1 if the firm exports in period t and 0 otherwise. π is the current increase to gross profs associated wh the decision to export; firmspecific characteristics, market characteristics and spillovers are included in s ; and other factors, such as aggregate exchange rate movements, trade policy condions, etc., are included in p t. J i is the age of the firm and j 1 ( ( 1 ) k = 1 ) y% = y y summarizes the firm recent export experience and, j, j, k takes the value of 1 if the last period that firm i exported was period t j and 0 otherwise. To account for sunk costs the following assumptions are made. First, a firm that has never exported faces an entry cost of 0 F and would earn the first 10 An extreme case is the office machines sector, wh no change of exporting status over the period. 9

11 year exporting (, ) π p s F 0. Second, a firm that exported in the previous year, i.e. if y i,t-1 =1, does not have to pay the entry cost in t and would earn π (, ) p s, t but if this firm decides to ex would incur in an ex cost represented by G. Finally, firms that abandon the export activy in previous periods (t - j wh j 2 ) and decide to re-start exporting again are also considered. In this case, we assume that the firm faces a re-entry cost of earnings π ( p, s ) i j F, which would leave the firm j F. The j subscript indicates that re-entry costs depend on the length a firm has been away from exporting. This could reflect the depreciation of knowledge and experience accumulated during the exporting period or the increasing cost of updating products, market channels, etc., to the changing foreign markets. We assume that in period t managers plan the firm export participation sequence that maximises the expected current and discounted future profs net of sunk costs. 11 This maximised payoff is, s t V = max E δ π t ˆis (2) yis s= t s= t where E t is an expectations operator condioned on the set of firm information at time t and δ is a time discount rate. Firm i chooses the current y value that satisfies the Bellman s equation: V = max ˆ π + δ E, + 1 V y Ji t i t j y j = 0. (3) A firm that decides to export in t gets the expected present value of payoffs Ji Ji 0 j 0 ( 1, ) (1 ) ( ) j = 1 π + δ + = % Et Vi, t 1 y y j F yi, t 1 F F y (4) i, t j and one that decides not to do J ( i 0, j = 1) δ = t i, t+ 1 j i, t 1 j = 2 E V y y G y. (5) The h firm will decide to export during period t whenever (4) minus (5) is posive, i.e. 11 We assume that the firm also chooses the prof-maximizing level of exports if decides to export. 10

12 0 0 j 0 ( ) ( ) ( ) ( ) π + δ + = + = + + % Et Vi, t 1 y 1 Et Vi, t 1 y 0 F F G yi, t 1 F F yi, t j 0. π * (6) The empirical specification is derived from (6). Defining the latent variable as current gross operating profs plus the discounted expected future return from being an exporting firm in year t, (, 1 1) (, 1 0) * π π δ = + Et Vi t + y = Et Vi t + y = (7) export participation is then given by the following dynamic discrete choice process: J i j = 2 y 1 if F + F + G y F F y% 0 = J i * 0 0 j 0 π ( ) i, t 1 ( ) i, t j j = 2 0 otherwise. (8) * 0 We approximate π F as a reduced-form expression on exogenous firm/market characteristics and spillovers (X ), macro condions ( µ t ), and noise (ε ). 12 Therefore, π * F 0 = µ + βx + ε. (9) t We also consider some identifying assumptions in relation to sunk entry, re-entry and ex costs. First, we assume that sunk costs do not vary across time. Second, we suppose that sunk entry costs for firms which did not export for at 0 0 least J years are the same, F = F, and that all firms which did not export for j < i j j J years incur in the same re-entry sunk costs, F = F. Finally, we consider that all firms currently exporting have the same ex cost Gi = G. i Using the above assumptions, re-defining F 0 F j = γ j for j = 2,,J, 0 0 F + G =γ, and substuting (9) into (8), we have the estimation equation: J 0 j 1 if µ + β + γ + γ + ε = % t X yi, t 1 yi, t j 0 y j = 2 (10) 0 otherwise. This equation can be adjusted to make sunk costs specific to size group. To do so we interact the lagged variables structure (that captures sunk costs) wh 12 All of them, wh the exception of ε, are assumed to be observable to the firm in period t. 11

13 the size group the firm belongs to. Then our final estimation equation is as follows, J J 0 j 0 j 1 if µ + β + γ + γ % + γ τ + γ % t X syi, t 1 syi, t j l syi, t 1 l syi, t jτ + ε 0 y (11) = 0 otherwise, j= 2 j= 2 0 where τ is 1 for large firms and 0 for small ones. F + G is γ 0 s for small firms and γ s γ l s 0 j for large firms. Finally, F F is γ j s j for small firms and γ + γ j s l s for large firms. Notice, from last expression, that the export decision in t does not depend on the firm exporting background if sunk costs are zero. This allows checking for 0 the importance of sunk costs: for small firms, we have to test whether γ s and j γ s are jointly equal to zero; for large firms we check whether γ and s γ l s γ + j s j γ l s are jointly equal to zero (for j = 2,, J). It is also possible to analyse the rate of depreciation of experience and accumulated knowledge in export activies by looking at the coefficients for large and small firms individually Estimation issues. Given that we are interested in isolating the effects of sunk costs hysteresis (true state dependence) in the exporting status, is crucial to control for all other sources of persistence. Most of this task is accomplished by including the vector of observable characteristics X in (11). However, is highly probable that there still remain unobserved factors causing persistence such as product attributes, foreign contacts, managerial abily or technology. Since they are potentially permanent, or highly serially correlated, in practice we assume that ε in (11) has two components, a permanent firm-specific effect ( α ) and a transory component ( u ). Hence, we allow for two sources of serial correlation in ε, the first arising from the permanent component and the second from serial correlation in transory shocks to exporting profs. We further assume that the ( X ε ) = i t, and normalize ( ) cov, 0, Var ε = 1. i 12

14 It is also needed to address an inial condions problem. We observe a firm exporting status in years 1 through T, and our lag structure reaches back J periods. Values corresponding to the first J years ( y,..., 1 y ) cannot be treated as exogenous determinants of y, when t > J, because each one depends on α i and previous realizations of u, both of which are correlated wh ε. Heckman (1981) suggests dealing wh this inial condions problem by using an approximate representation for y when t J. Specifically, let us suppose that expected profs in the export market during the J pre-sample years can be represented by the equation * 0 p p π F = λx + ε (12) where p X is a distributed lag in pre-sample realizations on exogenous variables. 13 Then, presample export-participation is described by p p 1 if λx + ε 0 y = (13) 0 otherwise instead of equation (11). We assume that ε p has the same properties than ε. P P Furthermore, is assumed that the joint distribution of ε,..., ε, ε,..., ε i ij is i1 ij ij+ 1 it multivariate standard normal, and s full correlation matrix is characterised by {( ) } T T T /2 free distinct (and estimable) correlations, wh ones on the diagonal and ρts = ρ as off-diagonal st elements.14 Roberts and Tybout (1997), Bernard and Wagner (1998) and Bernard and Jensen (2004) impose an AR(1) on the serial correlation of the transory components of ε and ε p. Campa (2004) does not allow for correlation of these components. Nevertheless, we leave fully unrestricted. Posive (negative) signs in the set of correlation coefficients between the disturbances of the first J periods and the disturbances in every other period, indicate that firms that were more likely to be exporters in inial condions years were more (less) likely to remain exporters during sample years compared to the 13 In the empirical work all the firm characteristics ( X ) are included as explanatory variables in p X. We also include two-year lagged values of the firm s continuous variables. 14 In our empirical work J=3 and T=10. 13

15 non-exporters. If these correlation coefficients are jointly equal to zero, there is no inial condions problem and the model reduces s dimension to a T - J multivariate prob model. And if ρts, t s, are all jointly equal to zero, then exporting equations may be estimated using simple univariate prob models. We estimate the general model wh free correlations and test for special cases. Our general model is a dynamic random effects multivariate prob model that we estimate using the mvprob Stata program 15 developed by Cappellari and Jenkins (2003). This program uses simulated maximum likelihood techniques (SML) to solve the computational problem of evaluating T-dimensional integrals. 16 In addion, the program allows implementing a pseudo simulated maximum likelihood estimator (PSML) that adjusts the estimates of the parameter covariance matrix to take into account arbrary correlations between all panel observations of a given firm (see Huber, 1967 and Whe, 1982) Explanatory variables. To parameterize the firm s exporting decision given by equation (11), we assume that variation in export profabily and start-up costs (other than unobserved components) may arise from four different sources: time-specific effects, industry dummies, observable differences in firm/market characteristics and spillovers. Time effects are included in order to capture macro-level changes in export condions that are common across firms, such as the influence of business cycle, cred-market condions, aggregate exchange rate movements (affecting relative prices from exporting and domestic sales), trade-policy, overall changes in demand for Spanish exports and other time-varying factors. Industry dummies to control for unobservable characteristics of markets where firms compete, such as market concentration, use of technology or firms specific behaviour by industry, are also included. 15 This program can be obtained at SSC public domain software archive ( or, inside Stata, type ssc install mvprob. 16 In particular, uses the Geweke-Hajivassiliou-Keane (GHK) simulator to replace multivariate standard normal probabily distribution functions by their simulated counterparts, see Hajivassiliou and Ruud (1994) and Gourieroux and Monfort (1996). 14

16 We also consider several hypotheses concerning the role of observable firm characteristics. Perhaps the most obvious are those related to past success. Although the usual claim is that better performing firms become exporters, a substantial fraction of export policies assumes instead that exporters will become good performing firms. To proxy for firm success we include age, size and productivy. Age proxies for efficiency differences. If market forces select out inefficient producers, older firms will tend to be more competive in world markets, eher because of cost advantages that cannot be imated by rivals or because they have had time to move down along a learning curve. 17 As pointed out by Bernard and Jensen (1999), even if the annual payoffs from exporting were the same for young and old firms, the young ones would perceive smaller returns from entering the export market because they face a higher risk of failure. Size may proxy for several effects: larger firms have been usually successful in the past, but size may be associated wh lower average or marginal costs, providing a separate mechanism for size to increase the likelihood of exporting. Another link between size and export may reflect scale economy-based exporting (Krugman, 1984). There are also reasons to expect firm productivy to increase the likelihood of exporting. If the fixed costs of selling are higher in the export market than in the domestic market or if output prices are lower, only firms wh high productivy will find profable to enter the export market. This is usually referred to as the self-selection hypothesis in the models of industry dynamics. 18 We discuss next the role of qualy of the labour-force. If exported goods have higher qualy, a higher value to weight ratio, or require new product design and other forms of technical assistance, then we would expect the qualy of the workforce to be posively related to entrance into foreign markets. A sizable body of research has focused on the role of ownership in crossborder trade. We control for the ownership structure of the firm (limed liabily corporation versus other, and foreign capal participation). One can think that 17 Roberts (1996) reports a decline in the probabily of failure as a plant ages for Colombia and Tybout (1996) reports a similar finding for Chile. The same pattern has been found in data from the US (see Dunne et al., 1989 or Baily et al., 1992). 18 See for example, Ericson and Pakes (1995), Pakes and Ericson (1998) or Baldwin and Rafiquzzaman (1995). Delgado, Fariñas and Ruano (2002) find evidence supporting the selfselection hypothesis using data drawn from the ESEE. 15

17 non-domestically owned firms may enjoy better access to foreign markets due to complementaries wh other business whin the same group. It has been frequently argued that firms participated by foreign capal are, in general, more efficient and so their presence in foreign markets should be higher. Furthermore, when foreign direct investment is based on competive advantages of the destination market, is expected a posive relation between foreign ownership and exporting activy. In this case, the domestic market might be seen as a productive platform. The decision to export can also be affected by domestic demand factors such as the evolution of domestic demand or the type of customer. If foreign markets became a relevant alternative in periods of low domestic demand, we would expect the probabily of exporting to be higher in these periods. If a firm s main customer is the public sector (due to the nature of the product) whenever this firm decides to export will have to face the possible preference of the foreign public sector for s own national producers. It can also happen that once domestic producers have adapted their production to meet the requirements of their domestic public sector, they may not be very much attracted by foreign markets. We also consider the effects of vertical and horizontal product differentiation strategies. As vertical differentiation is related to product qualy differentiation, we proxy for by using variables that measure the firm innovation-related activies such as R&D intensy, complementary technological activies and innovation results. We would expect that the higher the vertical differentiation of the firm, the higher the probabily of exporting. To account for horizontal differentiation, which is more identified wh different product perceptions from the demand side, we include firm s advertising intensy. The lerature on economic geography and trade (Krugman, 1992) hypothesizes that activies of neighbouring firms may reduce entry costs. The presence of other exporters may make easier, for domestically oriented firms, to break into foreign markets. A form of externaly might arise if the presence of other exporters lowers the cost of production, possibly by increasing the 16

18 availabily of specialized capal and labour inputs. We consider three forms of spillovers: region-specific, industry-specific and local to the industry and region. 19 Finally, in order to assess the importance of sunk costs and whether they differ between large and small firms, we use a lag structure for past participation that reaches back three periods and takes into account the possibily of different sunk costs according to size group. As noticed earlier, if sunk costs matter current participation will depend upon the exporting history. Table 6 provides detailed information on all the variables discussed above. All nominal variables have been deflated using specific industry deflators according to 20 sectors of the NACE-93 classification. Given that for some variables the direction of causaly remains uncertain, in the estimation we lag one year firm characteristics and other exogenous variables to avoid possible simultaney problems. [Insert Table 6 about here] 4. Estimation results. We treat the period as the J = 3 pre-sample years controlling for the inial condions problem. The values of the variables in 1990 are included as regressors for the 1991 inial condion. The observations for are used to estimate the relevant parameters in equation 11. [Insert Table 7 about here] In Table 7 we report the PSML estimates. A test for joint significance of all the ρ -correlation coefficients leads to rejection of the null hypothesis that they are jointly equal to zero. 20 Hence, the proper estimation method involves multivariate prob models. Furthermore, we also perform a test for endogeney of inial condions by testing the joint significance of ρ -correlation coefficients between inial condions (1990 < t 1993) and sample years errors (1993 < t 2000). Exogeney of inial condions is strongly rejected. Hence, inial condions should not be treated as exogenous. 19 See Bernard and Jensen (2004) and Clerides et al. (1998). 20 See the results of this test at the bottom of table 7. Table A.I in the Appendix reports the ρ - correlation coefficients between time periods. 17

19 4.1. Time dummies, firm/market characteristics and spillovers. We analyse the impact of time dummies, firm/market characteristics and * 0 spillovers on the expected profs, net of sunk entry costs (π F ), of a firm wh no previous experience in the export market. The 1995 and 2000 dummy coefficients are posive and significant at 5% and 10% levels, respectively. The estimate of the dummy for 1995 is probably capturing the peseta depreciation that took place after the bandwidth widening of the European Rate Mechanism. The dummy for 2000 could be reflecting the depreciation of the euro wh respect to the US dollar. 21 In addion, the hypothesis that the time dummies are jointly equal to zero cannot be rejected (the χ 2 6 test is and the corresponding p- value 0.109). This partial lack of responsiveness could suggest that the export decision is rather insensive to macro condions during the sample period. We also analyse the influence of observable firm/market characteristics. Only two out of the three variables included to proxy for firm past success have an impact on net export profabily: size (measured by the number of workers) and productivy. Larger and more productive firms are more likely to become exporters. The coefficient of age, often considered as a proxy for efficiency, is not significant. 22 The coefficient for the variable that proxies for labour force qualy is not significant. 23 However, this does not necessarily mean that a better qualy of the 21 From 1 st January 1999 exchange rates between the European Monetary Union national currencies are fixed and euro-dollar exchange rates determine the exchange rates between national currencies of the European Monetary Union and the US dollar. 22 Roberts and Tybout (1997), Bernard and Wagner (1998) and Bernard and Jensen (2004) find that size affects posively the probabily of exporting. Productivy appears not to be significant in most of the specifications in Bernard and Jensen (2004). However, is significant in most cases in Bernard and Wagner (1998). As for age, Roberts and Tybout (1997) find that older plants are more likely to export. The lack of significance of the variable age in our analysis may be due to the inclusion of the variable productivy, which might be capturing differences in efficiency that in Roberts and Tybout (1997) are picked up by the age variable. 23 Bernard and Wagner (1998) and Bernard and Jensen (2004) find significant and non significant effects of this variable, respectively. 18

20 labour force will not help to succeed in the export market. A more qualified labour force may contribute to vertically differentiate the firm product. However, the extent of product differentiation is better captured by other vertical product differentiation variables included in the analysis. Neher corporate ownership nor foreign capal participation are significant determinants of export participation. 24 The result on the foreign capal participation variable could be signalling that the aim of foreign investors is not necessarily using Spain as a productive platform but supplying the domestic market. As regards the influence of domestic demand factors, the evolution of domestic demand (measured by s growth rate) is not significant. However, firms selling a relevant part of their production to the public sector show a lower probabily of exporting. The probabily of exporting increases wh vertical product differentiation. Two of the three variables introduced to account for this effect are significant: the probabily of exporting increases both wh the intensy of R&D expendure and wh the realization of R&D complementary activies such as qualy controls or product normalization. The third variable, which controls whether the firm registers patents or process innovations, is not significant. This could be suggesting that patenting does not ensure exporting success. Horizontal product differentiation has also a posive impact on the probabily of exporting, as shows a posive and significant coefficient for advertising intensy. Finally, all measures of spillovers are non significant. Bernard and Jensen (2004) introduce the same three measures of spillovers and these are always nonsignificant or have a negative sign (contrary to expected) Sunk costs parameters. Wald tests for joint significance of the coefficients ˆ γ 0, ˆ γ 2 and γ 3 for small firms s s ˆs and of the coefficients ˆ γ + ˆ γ, ˆ γ + ˆ γ and s l s s l s ˆ γ + ˆ for large firms in (11) suggest 3 3 s γ l s 24 However, in Roberts and Tybout (1997) corporate ownership posively influences the probabily of exporting. 19

21 the rejection of the hypothesis that they are jointly equal to 0. For small firms, the χ 2 3 statistic is wh a p-value approximately 0; for large firms, the χ 2 3 statistic is wh a p-value approximately 0. Hence, even after controlling for a general form of serial correlation, exporting history matters. Regarding individual coefficients, for small firms, the estimated coefficient for y i,t-1 ( γ ) is large (2.032), posive and significant, revealing that exporting the 0 ˆs previous year has a strong posive impact on the probabily of exporting this year. Addionally, this coefficient can be considered as an estimate of the sum of sunk entry costs for a firm that never exported and ex costs for current exporters ( hysteresis band, Dix, 1989a). The coefficients of 2 3 y% ( ˆ γ ) and y % ( ˆ γ ) measure, respectively, the reductions in the full sunk, 2 s, 3 s entry costs faced by a new exporter enjoyed by firms that exported for the last time two and three years ago. Both coefficients are non significant, indicating a rapid depreciation of exporting experience; i.e. there is no significant difference between the entry cost of a firm that last exported two or three years ago and a firm that had never exported before. For large firms, the hysteresis band, that is the coefficient of y i,t ( ˆ γ + ˆ ) is significantly smaller (1.791) than the one of small firms, but still s γ l s posive and very significant (wh a p-value approximately 0). The coefficients of y% ( ˆ γ + ˆ γ ) and y % ( ˆ γ + ˆ γ ) are non significant, 25 and they do not differ, 2 s l-s, 3 s l-s significantly from ˆs γ 2 and ˆs γ 3, respectively. This indicates that for large firms exporting experience also depreciates que fast. 26 Although sunk costs are higher for small firms and so the persistence originated from sunk costs is larger for small firms than for large ones, persistence in the exporting status is higher for large firms (as observed in section 2). Therefore, the higher persistence of large firms in the exporting status might be due to other relevant sources of persistence such as differences in observed ( ˆ γ + ˆ γ ) is 0.062, wh a p-value 0.876, and ( ˆ γ + ˆ γ ) is 0.303, wh a p-value s l-s s 26 Our results are similar to those in Roberts and Tybout (1997). Bernard and Wagner (1998) and Bernard and Jensen (2004) include only two lags of export participation and both of them are found to be significant. Nevertheless, should be reminded that none of them considers the possibily of sunk costs differing between size groups. l-s 20

22 characteristics. Thus, the most relevant variables that affect posively and significantly export market participation, such as productivy, R&D and advertising intensy, complementary R&D or the number of employees (a continuous measure of size) show higher average values for the group of large firms than for the group of small firms (see Table 8) Goodness of f. Following Roberts and Tybout (1997), to evaluate the goodness of f of our model, we compare actual and predicted patterns of export market participation. For the seven-year period there are 128 (that is, 2 7 ) possible export market trajectories for an individual firm. 28 Across the 755 firms of our sample, some of these trajectories are eher never observed or are que unusual. Hence, to simplify the comparison of actual and predicted trajectories, we group the 128 possible trajectories into 6 categories based on two creria: first, the firm exporting status in 1994; and second, whether the firm changes exporting status once or more times between 1995 and Table 9 shows that actual and predicted frequencies for the six categories are que similar. Furthermore, the results of a chi-square contingency table test, comparing actual and predicted frequencies ( χ 2 =0.787 wh a p-value of 0.978), indicate that there are not significant differences between the two. These results suggest that our functional form, lags and error structure are appropriate and that our model predicts patterns of export market participation rather accurately. [Insert Table 9 about here] 27 Tests of differences in means for these variables between size groups allow rejecting the equaly of mean values. 28 Actual and predicted frequencies for the complete 128 possible trajectories are shown in Table A.II in the Appendix. 21

23 5. Concluding remarks. In this paper, we test both for the existence of sunk costs in the export decision by Spanish manufacturing firms and whether there are differences in sunk costs between large and small firms. We use a dynamic random effects multivariate prob model that allows controlling for competing sources of persistence: sunk costs, heterogeney and serial correlation in transory shocks. The data used have been drawn from the ESEE survey for the period This survey is representative of Spanish manufacturing firms. This paper differs from the existing lerature in the following respects. First, we use a richer set of firm characteristics (including vertical and horizontal product differentiation variables) and market characteristics (including industry, regional and local spillovers) that allows for a better identification of sunk costs. Secondly, we do not impose any structure on the serial correlation of transory shocks. Misspecification problems may arise from a given structure and may lead to inconsistent estimates for sunk costs. Thirdly, whereas most previous studies use plant data, our observation un is the firm, which is the appropriate one to analyse the export decision. Finally, we allow the sunk costs coefficients to vary across size groups to check whether these costs are different between large and small firms. We find evidence supporting the sunk cost explanation for hysteresis in Spanish manufacturing exports and that large firms face significantly smaller sunk costs in exporting than small firms. Furthermore, our estimation results indicate that in both size groups those firms leaving the export market suffer a rapid depreciation of their exporting experience. Re-entry costs that faces a firm that last exported two or three years ago are not significantly different from those faced by a new exporter. This phenomenon could be suggesting, for instance, that obtaining information about foreign demand condions is an important source of sunk costs of entry and that this information rapidly depreciates once a firm leaves the export market. Firm heterogeney is also an important source of persistence in the export market, as firm characteristics are relevant to explain firms exporting trajectories. Firms past success (as measured by size and productivy) has a posive impact on the probabily to export. Product differentiation also increases this probabily. As regards vertical product 22

24 differentiation, the probabily of exporting increases wh the intensy of R&D expendure and wh the realization of other R&D related activies such as qualy controls or product normalization. Firms that horizontally differentiate their products by means of advertising also have a higher probabily of exporting. Our findings make a significant contribution to the understanding of the determinants of firms decision to export and have important implications for public policy. The combined relevance of sunk costs and firm characteristics in the probabily of exporting suggest possible export promotion policies. On the one hand, policies directed at providing information and access to foreign markets or providing exporting infrastructures could reduce the sunk costs of entry, which is especially crucial for small firms. On the other hand, policies aimed to help firms to increase productivy or to stimulate product differentiation behaviours would have a posive impact on exporting. References. Baily, M.N., Charles, H., Campbell, D., Productivy dynamics in manufacturing firms. Brookings Papers on Economic Activy, Microeconomics, pp Baldwin, R.E., Hysteresis in import prices: the beachhead effect. American Economic Review 78, pp Baldwin, R.E., Sunk costs hysteresis. National Bureau of Economic Research Baldwin, R.E., Krugman, P.R., Persistent trade effects of large exchange rate shocks. Quarterly Journal of Economics 104(4), pp Baldwin, J.R., Rafiquzzaman, M., Selection versus evolutionary adaptation: learning and post-entry performance. International Journal of Industrial Organization 13, pp Bernard, A.B., Wagner, J., Export entry and ex by German firms. National Bureau of Economic Research Bernard, A.B., Jensen, J.B., Exceptional exporter performance: Cause, effect, or both? Journal of International Economics 47, pp Bernard, A.B., Jensen, J.B., Why some firms export? Review of Economics and Statistics 86 (2), pp

25 Campa, J.M., Exchange rates and trade: How important is hysteresis in trade? European Economic Review 48, pp Cappellari, L. and S. P. Jenkins, Multivariate prob regression using simulated maximum likelihood, The Stata Journal, 3(3), pp Clerides, S.K., Lach, S., Tybout, J.R., Is learning by exporting important? Micro-dynamic evidence from Colombia, Mexico, and Morocco. The Quarterly Journal of Economics, pp Delgado, M. A., Fariñas, J. C., Ruano, S., Firm productivy and export markets: a non-parametric approach. Journal of International Economics 57, pp Dix, A., 1989a. Entry and ex decision under uncertainty. Journal of Polical Economy 97(3), pp Dix, A., 1989b. Hysteresis import penetration exchange rate pass-through. Quarterly Journal of Economics 104, pp Dunne, T., Roberts, M.J., Samuelson, L., The growth and failure of U.S. manufacturing plants. Quarterly Journal of Economics 105(4), pp Ericson, R., Pakes, A., Markov-perfect industry dynamics: a framework for empirical work. Review of Economic Studies 62, pp Esteve, S., Sanchis, A., Sanchis, J.A., The determinants of survival of Spanish manufacturing firms. Review of Industrial Organization 25, pp Gourieroux, C., Monfort, A., Simulation-based econometric methods. Universy Press, Oxford. Hajivassiliou, V., Ruud, P., Classical estimation methods for LDV models using simulation, in: Engle, R., McFadden, D. (Eds.), Handbook of Econometrics. North-Holland, Amsterdam, pp Heckman, J.J., The incidental parameters problem and the problem of inial condions in estimating a discrete time-discrete data stochastic process, in: Manski, C., McFadden, D. (Eds.), The structural analysis of discrete data. MIT Press, Cambridge, pp Huber, P.J., The behaviour of maximum likelihood estimators under nonstandard condions, in: Proceedings of the Fifth Berkeley Symposium in Mathematical Statistics and Probabily. Universy of California Press, Berkeley CA, pp Krugman P.R., Import protection as export promotion: International competion in the presence of oligopoly and economies of scale, in: Kierzkowski, H. (Ed.), Monopolistic competion and international trade. Universy Press, Oxford, pp Krugman P.R., Exchange-rate instabily. MIT Press, Cambridge. 24