DP13699 The Comparative Advantage of Firms

Author(s):	Johannes Boehm, Swati Dhingra, John Morrow
Publication Date:	April 2019
Keyword(s):	comparative advantage, Economies of scope, firm capabilities, Multiproduct Firms, size-based policies, vertical input linkages
JEL(s):	F11, L25, M2, O3
Programme Areas:	Industrial Organization, International Trade and Regional Economics, Development Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=13699

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.