Multi-Product Firms and Flexible Manufacturing in the Global Economy

1. Multi-Product Firms and Flexible Manufacturingin the Global Economy J. Peter Neary University of Oxford and CEPR

2. Multi-product firms (MPFs) … Bernard, Redding, Schott (2006) are present in all industries typically coexist with single-product firms account for 41% of the total number of firms 91% of total output are very active in varying their product mix (50% both add and drop products, 30% drop only, 8% add only during average 5 year interval) Evidence on Multi-Product Firms

4. Existence, Market Structure, and Diversification: Brander-Eaton (1984); Klemperer (1992); Eaton-Schmitt (1994); Baldwin-Ottaviano (2001); Johnson-Myatt (2003, 2006); Grossmann (2005) Free Entry Models based on Fixed Costs: Ottaviano-Thisse (1999); Baldwin, Gu (2005); Allanson-Montagna (2005) MPFs and Trade: Evidence and Theory Bernard-Redding-Schott (2005, 2006); Nocke-Yeaple (2005) Literature on Multi-Product Firms

5. Develop a new model of multi-product firms (MPFs) based on flexible manufacturing Explore intra-firm adjustments within MPFs in partial and general oligopolistic equilibrium (GOLE) Show how the existence of MPFs alters predictions of conventional trade models Our Contribution

6. General Oligopolistic Equilibrium (GOLE) [Neary (2002)] Continuum of identical industries [0,1], k identical countries, MPFs in all [D.P. has asymmetric countries and industries: similar results] Globalization: Increase in the number of countries Both a market-size and a competition effect Overview of the Model

7. Consumers and Firms Industry Equilibrium Scale and Scope of MPFs Comparative Statics General Equilibrium The Global Economy Adjustment to Globalization Extensions Country/Firm Asymmetries Free Entry Outline

8. Consumers and Firms Industry Equilibrium Scale and Scope of MPFs Comparative Statics General Equilibrium The Global Economy Adjustment to Globalization Extensions Country/Firm Asymmetries Free Entry Outline

9. Preferences and Demand Continuum Quadratic Preferences: Neary (JEEA 2003), Ottaviano-Tabuchi-Thisse (IER 2002) Inverse World Market Demand:

10. Demand: Flexible Manufacturing: Profits: Firm Output: F.O.C. Scale: F.O.C. Scope: Costs and Technology of Multi-Product Firms

11. Flexible Manufacturing Product Range "Core Competence"

12. First Order Condition: Scale "Cannibalization Effect"

13. First Order Condition: Scope Product Range "Core Competence"

14. Equilibrium Output Profile "Core Competence" Product Range

15. Prices: Price-Cost Margins: Multi-Product Firms (cont.) [“km” is the competition effect; “-1” is the cannibalization effect] • Prices vary across varieties • Compare models with fixed costs: e.g., Nocke-Yeaple • Higher prices and lower profit margins on goods further from a firm’s core competence

16. Scale and Scope Combined Industry Output: Y=kmX Firm Scale: Firm Scope: i.e., 2 equations in X and d. Combine: a(d): Cost savings from flexible manufacturing

17. First Order Condition: Scope Cost savings from flexible manufacturing Product Range "Core Competence"

18. Consumers and Firms Industry Equilibrium Scale and Scope of MPFs Comparative Statics General Equilibrium The Global Economy Adjustment to Globalization Extensions Country/Firm Asymmetries Free Entry Outline

19. FOC: Scope Industry Output: Y=kmX Scope:d(X) X

20. FOC Scale Scale: X(d) X

21. Figure 3: Industry Equilibrium Scale: X(d) Scope:d(X) X

22. Market-Size Effect of Globalization Scale: X(d) Scope:d(X) X

23. Market-Size Effect on Output Profile Product Range

24. Competition Effect of Globalization Scale: X(d) Scope:d(X) X

25. Competition Effect on Output Profile Product Range

26. Full Effect of Globalization Scale: X(d) Scope:d(X) X

27. Intra-Firm Adjustment

28. Intra-Firm Adjustment X rises, so infra-marginal products must increase

29. Intra-Firm Adjustment Outputs rise Outputs fall

30. Proof here for X; also holds for a price-weighted Divisia Index Output: Impact on Productivity Labour Demand: Productivity: • This is decreasing in d • So: globalization encourages “leaner” firms

31. Low Flexibility High Flexibility Impact on Product Variety

32. Partial Equilibrium Results Proposition 1: In partial equilibrium, an increase in competition reduces δ and X but raisesY. An increase in the size of the market increases both Xand Y but leaves δunaffected. Proposition 2: Firm productivity depends negatively on d and on nothing else. Hence it rises when competition increases but is independent of the size of the market. Proposition 3: In partial equilibrium, the impact of globalization on N depends on the degree of flexibility in manufacturing. If flexibility is low, N rises as k increases, otherwise N falls. A necessary condition for a fall in N is that costs are concave in varieties.

33. Consumers and Firms Industry Equilibrium Scale and Scope of MPFs Comparative Statics General Equilibrium The Global Economy Adjustment to Globalization Extensions Country/Firm Asymmetries Free Entry Outline

34. Firm Scope: Firm Scale: Labour Market Equilibrium: Overview of GE Model 3 Equations:

35. Scale and Scope in General Equilibrium Recap: Firm Scale: Firm Scope:

36. Industry Equilibrium w IE: X(w) X

37. LD Multi-product Firms: Labour Market Equilibrium: Labour Market Combine with FOC (scale): Combine with FOC (scope):

38. Labour-Market Equilibrium w LL: w(X) X

39. Figure 5: General Equilibrium w IE: X(w) LL: w(X) X

40. Market-size and competition effects as in PE Responses of X and das in PE Wage rate may rise or fall (presumptively rises in linear case) Product range more likely to fall when w rises Adjustment to Globalization in GE: Summary

41. Consumers and Firms Industry Equilibrium Scale and Scope of MPFs Comparative Statics General Equilibrium The Global Economy Adjustment to Globalization Extensions Country/Firm Asymmetries Free Entry Outline

42. Industry Equilibrium: Heterogeneous Firms Multi-product firms with longer product lines and more flexible technology tend to respond more to shocks

43. Profits: Free Entry • In free-entry equilibrium, profits are: • Decreasing in m: Negative competition effect • Increasing in L: Positive market-size effect • Increasing in k: Market-size effect dominates • Hence: Rise in k encourages entry, reinforcing earlier results: • Firm output may fall, but national output mX must rise • dfalls, so productivity rises

44. Effect on diversity with no entry Magnification effect Free Entry (cont.) Effect on Product Diversity: Recall: No market-size effect on diversity with no entry i.e., Effect on diversity is qualitatively the same as in no-entry case, but magnified in absolute value

45. Globalization can have a considerable impact on both scale and scope of multi-product firms Introduces a new margin of adjustment: Intra-firm extensive margin “Cannibalization effect” crucial→ Oligopoly important Impact on scope depends on wage effects→ General equilibrium important New source of gains from trade: productivity increases, as firms become “leaner”: concentrate on their core competence New source of losses from trade: Variety may fall Impact on variety depends on flexibility→ Fall in diversity possible even with symmetry & w/out entry Entry (inter-firm extensive margin) reinforces intra-firm effect Conclusion

46. Thank you!