Country Size, International Trade, and Aggregate Fluctuations in Granular Economies

Abstract

This paper proposes a new mechanism by which country size and international trade affect macroeconomic volatility. We study a multi-country, multi-sector model with heterogeneous firms that are subject to idiosyncratic firm-specific shocks. When the distribution of firm sizes follows a power law with an exponent close to −1, the idiosyncratic shocks to large firms have an impact on aggregate output volatility. We explore the quantitative properties of the model calibrated to data for the 50 largest economies in the world. Smaller countries have fewer firms, and thus higher volatility. The model performs well in matching this pattern both qualitatively and quantitatively: the rate at which macroeconomic volatility decreases in country size in the model is very close to what is found in the data. Opening to trade increases the importance of large firms to the economy, thus raising macroeconomic volatility. Our simulation exercise shows that the contribution of trade to aggregate fluctuations depends strongly on country size: in the largest economies in the world, such as the U.S. or Japan, international trade increases volatility by only 1.5-3.5%. By contrast, trade increases aggregate volatility by some 15-20% in a small open economy, such as Denmark or Romania.JEL Classifications: F12, F15, F41

Input Linkages and the Transmission of Shocks: Firm-Level Evidence from the 2011 Tohōku Earthquake

“…The large expansions in trade and foreign direct investment (FDI) in the past twenty years have generated much discussion in whether they increase volatility (di Giovanni and Levchenko (2012)), increase comovement (Frankel and Rose (1998), Burstein, Kurz, and Tesar (2008)) or lead to less diversified production and specialization (Imbs (2004)). Identifying the micro-foundations underlying the role of these linkages in the increased co-dependence of national economies is a complicated task, however.…”

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Superstar Exporters: An Empirical Investigation of Strategic Interactions in Danish Export Markets

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