Final Report Summary - FIRMSFLUCTUATIONS (Firms, International Trade, and Aggregate Fluctuations)
A long tradition in macroeconomics seeks to understand the microeconomic underpinnings of aggregate fluctuations. Starting with the seminal work of Long and Plosser (1983), an important line of research explores the role of sectoral shocks in generating aggregate fluctuations (see, e.g. Stockman, 1988; Horvath, 1998, 2000; Dupor, 1999; Foerster et al., 2011; Carvalho and Gabaix, 2013., among others). The role of firms in the aggregate business cycle has received comparatively less attention. Gabaix (2011) argues that because the firm size distribution is extremely fat-tailed – the economy is “granular” – idiosyncratic shocks to individual (large) firms will not average out, and instead lead to aggregate fluctuations. Acemoglu et al. (2012) develop a network model in which idiosyncratic shocks to a single firm or sector can have sizable aggregate effects if it is strongly interconnected with other firms/sectors in the economy, regardless of the size distribution.
The importance of firms and linkages across the economy also arise in practical discussions of what drive macroeconomic fluctuations. For instance, according to a 2012 JPMorgan report, sales of Apple’s iPhone 5 could have added as much as half a percentage point to US 4th quarter GDP growth that year. While, in France, the recent poor performance of Renault and Peugeot is expected to induce a domino effect across the production chain. There are plenty of other examples of the importance of large firms in other economies (e.g. Nokia in Finland, or Samsung in Korea). However, despite these examples and a growing body of theoretical literature, there is currently little empirical evidence on the importance of large firms in generating aggregate fluctuations of output.
My research project aims to fill this gap in the empirical literature by exploiting detailed firm-level data. Furthermore, the research will also highlight the importance of international trade in measuring the role of large firms in generating aggregate fluctuations, thereby providing a link between the macroeconomics and international economics literatures.
The key objectives of the project are to:
O1. Construct a new firm-level dataset that merges firm domestic and export sales, along with other firm-level characteristics.
O2. Identify firm-level idiosyncratic shocks by exploiting the export-orientation of firms.
O3. Quantify the contribution of the idiosyncratic shocks to the volatility of aggregate sales growth.
O4. Measure the importance of firm-level interconnectedness in propagating idiosyncratic shocks into aggregate volatility.
O5. Estimate how a firm’s export and import orientations affect its exposure to shocks, as well as its ability to diversify risk.
O6. Quantify the implications of firms’ export and import orientations on aggregate volatility.
I begin by achieving the first four main objectives (O1-O4) in my proposal. In particular, I first gained access to the detailed French data, and merged firm-level and export data together (O1). I have results that identify firm-level idiosyncratic shocks by exploiting the export-orientation of firms, in a reduced formed regression framework, which exploited the rich panel of data (O2). I also have work that shows that these idiosyncratic shocks contribute a significant amount to aggregate volatility of total sales and value added (O3). I have also used sectoral input-output tables to measure firm-level interconnectedness, show that firms with greater such connection also have a higher correlation of idiosyncratic shocks (O4).
In particular, my results based on these first four objectives show that idiosyncratic shocks can explain up to 70% of aggregate volatility, which highlights the importance of large firms. Furthermore, the importance of interconnectedness points to the importance of linkages in transmitting shocks via input-output linkages. These empirical results provide evidence of recent channels highlighted in Gabaix (2011) and Acemoglu et al. (2012). These were published in “Firms, Destinations, and Aggregate Fluctuations” (Econometrica 2014, with Levchenko and Mejean).
I next move on to the final two objectives (O5-O6) to examine how firms’ import and export positions, as well as their multinational status, impact how foreign shocks are passed-through to the firms via these linkages, and what the microeconomic estimates imply about the overall transmission of shocks to the aggregate economy. In particular, I study whether the annual growth rates valued added for firm that have some form of international connection with another country are more correlated with those countries’ annual GDP growth compared to firms that do not have these connections. I.e. ask whether firms comove more with countries that they share international linkages. My results show that this is indeed the case. Moreover, when aggregating these results to the macroeconomic level, the overall impact of the microeconomic linkages implies that countries comove more if they share greater trade linkages. Therefore, these international linkages have the possibility of exposing both the firms and the overall economy risks emanating from outside their borders. This research has thus far been published in working paper format in “The Micro Origins of International Business Cycle Comovement” (with Levchenko and Mejean).
Overall these results provide novel microeconomic findings that help researchers better understand the role of firms in generating macroeconomic volatility, as well as their importance in the transmission of shocks across borders. This work has thus far focused on the use of big data combined with simple reduced form empirical strategies. Therefore, the results provide a rich set of new facts for future researchers to work on, as well as opening the door for further structural analysis of the economic channels at play. From a policy perspective, measuring the quantitative importance of large firms, both in the domestic and international context, highlights the need to monitor the economic health of key firms (or sectors) of the economy, as well as their linkages both within and across borders, in order to protect the economy from potentially negative macroeconomic consequences emanating from microeconomic shocks.
The importance of firms and linkages across the economy also arise in practical discussions of what drive macroeconomic fluctuations. For instance, according to a 2012 JPMorgan report, sales of Apple’s iPhone 5 could have added as much as half a percentage point to US 4th quarter GDP growth that year. While, in France, the recent poor performance of Renault and Peugeot is expected to induce a domino effect across the production chain. There are plenty of other examples of the importance of large firms in other economies (e.g. Nokia in Finland, or Samsung in Korea). However, despite these examples and a growing body of theoretical literature, there is currently little empirical evidence on the importance of large firms in generating aggregate fluctuations of output.
My research project aims to fill this gap in the empirical literature by exploiting detailed firm-level data. Furthermore, the research will also highlight the importance of international trade in measuring the role of large firms in generating aggregate fluctuations, thereby providing a link between the macroeconomics and international economics literatures.
The key objectives of the project are to:
O1. Construct a new firm-level dataset that merges firm domestic and export sales, along with other firm-level characteristics.
O2. Identify firm-level idiosyncratic shocks by exploiting the export-orientation of firms.
O3. Quantify the contribution of the idiosyncratic shocks to the volatility of aggregate sales growth.
O4. Measure the importance of firm-level interconnectedness in propagating idiosyncratic shocks into aggregate volatility.
O5. Estimate how a firm’s export and import orientations affect its exposure to shocks, as well as its ability to diversify risk.
O6. Quantify the implications of firms’ export and import orientations on aggregate volatility.
I begin by achieving the first four main objectives (O1-O4) in my proposal. In particular, I first gained access to the detailed French data, and merged firm-level and export data together (O1). I have results that identify firm-level idiosyncratic shocks by exploiting the export-orientation of firms, in a reduced formed regression framework, which exploited the rich panel of data (O2). I also have work that shows that these idiosyncratic shocks contribute a significant amount to aggregate volatility of total sales and value added (O3). I have also used sectoral input-output tables to measure firm-level interconnectedness, show that firms with greater such connection also have a higher correlation of idiosyncratic shocks (O4).
In particular, my results based on these first four objectives show that idiosyncratic shocks can explain up to 70% of aggregate volatility, which highlights the importance of large firms. Furthermore, the importance of interconnectedness points to the importance of linkages in transmitting shocks via input-output linkages. These empirical results provide evidence of recent channels highlighted in Gabaix (2011) and Acemoglu et al. (2012). These were published in “Firms, Destinations, and Aggregate Fluctuations” (Econometrica 2014, with Levchenko and Mejean).
I next move on to the final two objectives (O5-O6) to examine how firms’ import and export positions, as well as their multinational status, impact how foreign shocks are passed-through to the firms via these linkages, and what the microeconomic estimates imply about the overall transmission of shocks to the aggregate economy. In particular, I study whether the annual growth rates valued added for firm that have some form of international connection with another country are more correlated with those countries’ annual GDP growth compared to firms that do not have these connections. I.e. ask whether firms comove more with countries that they share international linkages. My results show that this is indeed the case. Moreover, when aggregating these results to the macroeconomic level, the overall impact of the microeconomic linkages implies that countries comove more if they share greater trade linkages. Therefore, these international linkages have the possibility of exposing both the firms and the overall economy risks emanating from outside their borders. This research has thus far been published in working paper format in “The Micro Origins of International Business Cycle Comovement” (with Levchenko and Mejean).
Overall these results provide novel microeconomic findings that help researchers better understand the role of firms in generating macroeconomic volatility, as well as their importance in the transmission of shocks across borders. This work has thus far focused on the use of big data combined with simple reduced form empirical strategies. Therefore, the results provide a rich set of new facts for future researchers to work on, as well as opening the door for further structural analysis of the economic channels at play. From a policy perspective, measuring the quantitative importance of large firms, both in the domestic and international context, highlights the need to monitor the economic health of key firms (or sectors) of the economy, as well as their linkages both within and across borders, in order to protect the economy from potentially negative macroeconomic consequences emanating from microeconomic shocks.