How does uncertainty shape firms’ export decisions?

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José de Sousa, Anne-Célia Disdier* and Carl Gaigné

According to recent surveys by Capgemini, demand uncertainty is a key factor in the decisions of international companies. This view is consistent with the empirical evidence that uncertainty plays a crucial role in a wide range of economic outcomes, such as investment, output and price decisions.

Trade theory typically assumes that consumer expenditures in foreign markets are known with certainty. Accordingly, firms know exactly the demand addressed by foreign consumers and only the first central moment of the expenditure distribution, i.e., market size, plays a role in export decisions and export sales. Although uncertainty has been introduced in various trade models, the uncertain parameter (productivity) is revealed before the firm supplies any destination. Recently, the trade literature has witnessed a revival of interest in studying the uncertainty realized after the firm enters any destination. In accordance with the theory of investment under uncertainty (1), export entry decisions also depend on the variance of expenditures. Firms face uncertain destination-specific demands that are realized after they enter the market. However, this recent literature assumes that uncertainty is resolved before firms set their prices (or quantities) for each destination under certainty. Under these circumstances, export prices and quantities (thus, export sales) are not affected by demand uncertainty. In practice, exporters may not observe some random shocks before the time-strategic variables (prices or quantities) are chosen. Numerous factors are beyond the producer’s control and influence the expenditure realization, including climatic conditions, changes in consumer tastes/incomes, etc.

In this paper, José de Sousa, Anne-Célia Disdier and Carl Gaigné show that economic uncertainty in foreign markets affects not only the decisions of entry/exit on the export market (extensive margin) but also the sales decisions of exporters (intensive margin), leading to the reallocation of market shares across firms. Using French firm-level data, the authors observe the destination countries to which firms export and the products they sell over the 2000-2009 period. They match these firm-level export data with industry-wide measures of expenditure uncertainty in the destination countries, such as the variance (or volatility) and the skewness of expenditure. A basic rationale for the role of skewness is that, for a given mean and variance, an increase in the skewness of the expenditure distribution involves a lower probability of low returns. With these data, the authors uncover two main empirical regularities regarding the role of industry-wide expenditure uncertainty in firms’ decisions in foreign markets.

First, demand uncertainty in foreign markets affects export entry/exit decisions (extensive margin) and export sales (intensive margin). If all destination countries exhibited the lowest volatility observed across destinations, then total French exports would rise by approximately 18% (an increase primarily driven by the extensive margin). Expenditure uncertainty also makes exports less sensitive to trade policy. Second, the most productive exporters are more affected by a higher industry-wide expenditure volatility than are the least productive exporters. The 25% most productive firms export, on average, 27% more in value than the 25% least productive firms in less volatile markets, while this difference decreases to 12% in the most volatile markets.

Even if the largest firms have access to better risk management strategies, they can only partially diversify against risk. In addition, according to the production theory under uncertainty, the variance of firm profit is proportional to the square of the expected output, meaning that the average risk premium increases with firm size. Hence, the results suggest that risk exposure is a disadvantage for the largest firms.

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Original title: Export Decision under Risk
Forthcoming in: the European Economic Review.
Available at: https://halshs.archives-ouvertes.fr/halshs-02332958

Photo credit: StockStudio (Shutterstock)

Reference
(1) Dixit, A. K. and R. S. Pindyck, 1994, Investment under Uncertainty, Princeton University Press.