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Title: The Comparative Advantage of Firms

Author(s): Johannes Boehm, Swati Dhingra and John Morrow

Publication Date: April 2019

Keyword(s): comparative advantage, Economies of scope, firm capabilities, Multiproduct Firms, size-based policies and vertical input linkages

Programme Area(s): Development Economics, Industrial Organization and International Trade and Regional Economics

Abstract: 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.

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Bibliographic Reference

Boehm, J, Dhingra, S and Morrow, J. 2019. 'The Comparative Advantage of Firms'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=13699