Capacity Constrained Exporters: Identifying Increasing Marginal Cost

This study revisits a central assumption of standard trade models: constant marginal cost technology. The presence of increasing marginal costs for exporters introduces significant market interdependence across borders missing from traditional models of international trade that rely on constant marginal cost technology. Such market interdependence represents an additional channel through which local shocks are transmitted globally. To identify increasing marginal cost at the level of the firm, we build in flexible production assumptions that nest increasing, decreasing, and constant marginal cost technology to an otherwise standard international trade model. We derive an estimating equation that can be taken directly to the data. Our structural equation explicitly guides our inference on the shape of marginal cost from estimated coeffi- cients. The results suggest that increasing marginal cost is predominant at the firm level, and that the degree of increasing marginal cost is significantly exacerbated by both physical and financial constraints. The evidence suggests that access to larger markets through greater international integration may not have the expected welfare gains typically predicted in standard models.