International Trade and the Firm Size Distribution

This paper studies the differences in firm size distributions between European countries. We start by documenting large differences using the EFIGE database: in the countries under most severe distress in the sample (Italy and Spain) firms are relatively small compared with the remaining countries. To account for this, we develop a multi-country, continuous time version of Melitz (2003) with endogenous process innovation. Firms choose when to become exporters by paying a sunk export cost. This gives them access to a larger market, increases profits and provides incentives to grow faster. We analytically derive both an endogenous steady state Pareto size distribution of firms and the transitional distribution between steady states. The model allows us to identify the main source of the distribution's difference: export costs. This sharply contrasts the predictions of a closed economy model, where heterogeneous innovation costs account for the difference. Additionally we identify strong microeconomic similarities among countries that at first appear different, such as Spain and U.K., and strong microeconomic differences between countries that appear similar, such as Austria and Germany. International trade is essential to uncover these patterns.