In the analysis of the decision to export it seems sensible to think that firms face costs associated with entering foreign markets that may be sunk in nature. For instance, non-exporting firms have to research foreign demand and competition, establish marketing and distribution channels, adjust their product characteristics and packaging to meet foreign tastes and/or fulfil quality and security legislation of other countries.
Acknowledging the existence of sunk costs implies that current exports depend on past export trajectories and, more interestingly, that transitory changes in trade policy or conditions may lead to permanent changes in market structure, that is, sunk entry or exit costs produce hysteresis in export flows. Furthermore, when there is uncertainty about market conditions, the existence of sunk costs affects the entry and exit patterns as trade flows are less responsive to changes in market conditions, such as exchange rates or incentives (subsidies) for exports.
It is important to note that although persistence in exporting status might be caused by sunk costs, it might also be due to either underlying (observed and unobserved) firm heterogeneity or serial correlation in transitory shocks to exporting profits. Therefore, in order to identify the role of sunk costs one would need an econometric framework that allows controlling for all competing sources of persistence in export behaviour.
The first attempt to tackle the sunk-cost hysteresis hypothesis in the empirical literature on exporting is Roberts and Tybout (1997), who directly analyse entry and exit patterns using plant-level panel data for Colombian manufacturing. More recent empirical evidence on sunk costs hysteresis are Bernard and Wagner (1998), Bernard and Jensen (2004) and Campa (2004), for German plants, U.S. plants and Spanish firms, respectively.
The objective of this paper is to assess the importance of sunk costs hysteresis examining the decision of firm export participation and to test whether sunk costs differ between large and small firms, using panel data for Spanish manufacturing firms, drawn from the Encuesta sobre Estrategias Empresariales (hereafter, ESEE), for the 1990s. To account for different causes of persistence we implement a dynamic random effects multivariate probit model, which is estimated by simulated maximum likelihood techniques.
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