Publication Date: November 2021
Larger Indian ﬁrms selling inputs to other ﬁrms tend to have more customers, tend to be used more intensively by their customers, and tend to have larger customers. Motivated by these regularities, I propose a novel empirical model of trade featuring endogenous formation of input-output linkages between spatially distant ﬁrms. The empirical model consists of (a) a theoretical framework that accommodates ﬁrst order features of ﬁrm-to-ﬁrm network data, (b) a maximum likelihood framework for structural estimation that is uninhibited by the scale of data, and (c) a procedure for counterfactual analysis that speaks to the eﬀects of micro- and macro- shocks to the spatial network economy. In the model, ﬁrms with low production costs end up larger because they ﬁnd more customers, are used more intensively by their customers and in turn their customers lower production costs and end up larger themselves.In the model, diﬀerences in production costs across ﬁrms arise not just from diﬀerences in productivity but also from ﬁnding the most cost-eﬀective suppliers of intermediate inputs. Firms with low production costs end up larger because they ﬁnd more customers, are used more intensively by their customers and in turn their customers lower production costs and end up larger themselves. The model is estimated using novel micro-data on ﬁrm-to-ﬁrm sales between Indian ﬁrms. The estimated model implies that a 10% decline in inter-state border frictions in India leads to welfare gains ranging between 1% and 8% across districts. Moreover, over half of the variation in changes in ﬁrms’ sales to other ﬁrms can be explained by endogenous changes in the network structure.
Keywords: Network formation, Production networks, Firm-to-firm networks, International trade, Economic geography, Spatial economics
JEL Classification Codes: F11, F12, D24, C67, C68, L11, O11, O12, R12, R15