Firm Heterogeneity and Imperfect Competition in Global Production Networks

We study the role of firm heterogeneity and imperfect competition for global production networks and the gains from trade. We develop a quantifiable trade model with (i) two-sided firm heterogeneity, (ii) matching frictions, and (iii) oligopolistic competition upstream. Combining highly disaggregated data on firms' production and trade transactions for China and France, we present empirical evidence in line with the model that cannot be rationalized without features (i)-(iii). Downstream French buyers import higher volumes and quantities at lower prices when upstream Chinese markets become more competitive. These effects are stronger for larger, more productive buyers and weaker when input suppliers are more heterogeneous. Counterfactual analyses indicate that lower barriers to entry upstream, lower matching costs, and lower trade costs amplify firm productivity, firm size dispersion and aggregate welfare downstream. These effects operate through a combination of improved matching of buyers and suppliers, gains from variety, and lower mark-ups. Global production networks thus generate greater impacts and international spillovers from national industrial policy and trade liberalization.