Occupational Choice, Aggregate Productivity, and Trade

• Date: 01 August 2013
• Published date: 01 August 2013
• DOI: http://doi.org/10.1111/rode.12049

Occupational Choice, Aggregate Productivity,

and Trade

Jürgen Meckl and Benjamin Weigert*

Abstract

We propose occupational decisions of heterogeneous individuals as an alternative mechanism of explaining

the distribution of firm productivities emphasized by empirical studies. Thus, we integrate the frameworks

of Melitz (Econometrica 71 (2003):1695–725), and of Manasse and Turrini (Journal of International Eco-

nomics 54 (2001):97–117) that establish the theoretical base of trade models with heterogeneous firms. Our

model is technically much simpler than the Melitz approach while preserving the main results on firm-

selection effects caused by international market integration. Our approach paves the way for detailed

analysis of institutions in a heterogeneous firm model to better understand the link between institutions

and an economy’s productivity distribution.

1. Introduction

The literature on heterogeneous firms emphasizes the effects of firms’ self selection in

response to trade liberalization. Three effects are identified as typical reactions to

product markets becoming increasingly integrated: (i) highly productive firms that

already have been exporting before expand; (ii) additional medium-productive firms

will become exporters; (iii) low productive firms exit the market (cf., e.g. Economidou

and Murshid, 2008). The most popular theoretical explanation of these firm-selection

effects is Melitz (2003). In his model of heterogeneous firms the equilibrium number

of active firms is endogenously determined as result of a dynamic market entry game.

By entering markets firms make an irreversible investment to discover their specific

productivity. After realizing their productivity, a firm decides whether to concentrate

on its domestic market, to be active on both national and international markets, or to

exit.

Despite its formal elegance and although it constitutes the fundamental base in the

literature on heterogeneous-firms trade models (cf. Bernard et al., 2007), the applica-

tion of Melitz’s approach is afflicted to the following drawbacks. (i) Because of the

complexity of the dynamic market-entry game, Melitz restricts his analysis to steady-

state equilibria. This constitutes a severe limitation of his model especially with

respect to practical applications of his results (this primarily applies to welfare

results). (ii) The assignment of productivities to firms is modeled as a highly abstract

process—firms simply draw their productivity from a pool of productivities—that is

hardly open to economic interpretation. Additionally, in order to generate a distribu-

tion of firm productivities that is in accord with the empirical observations, this distri-

bution of productivities has to be specified appropriately.1

*Meckl: Justus-Liebig-University Giessen, Department of Economics, Licher Str. 66, 35394 Giessen,

Germany. Tel: +49-641-9922110; Fax: +49-641-9922119; E-mail: juergen.meckl@wirtschaft.uni-giessen.de.

Weigert: German Council of Economic Experts, Statistisches Bundesamt, 65189 Wiesbaden, Germany. For

useful comments, we are grateful to Max Albert, Hartmut Egger, Udo Kreickemeier, Wilhelm Kohler, and

two anonymous referees.

Review of Development Economics, 17(3), 549–558, 2013

DOI:10.1111/rode.12049

© 2013 John Wiley & Sons Ltd