Information, Networks, and Learning: Variation of Entry Costs across Firms

Although the basic framework is intuitive, it also seems likely that the export or investment decision is driven not just by the variation in how efficiently production at home is organized but also by differences in how well foreign markets are understood. This variation in information about destination markets among firms is captured here through heterogeneity in sunk entry costs among firms. The sources of the variation may reflect the level of embeddedness of the firm in the destination market or sector globally, the existing networks in the destination market, and tacit knowledge of the market or the business operating environment. These issues highlight the importance of “social capital,” that is, the value of social networks and relationships in conducting business. Networks may provide access to information and influence and to finance and potential assistance in hard times, and may lower search and other transaction costs through greater inherent trust. With networks, it is not just “who you know” that matters but “who and what who you know knows.” The greater the networks of your connection, the greater the value of that relationship. Thus, although productivity is important, a less efficient firm with family connections in the destination market may export or invest, while a higher-productivity firm without such connections may not (see Boisso and Ferrantino 1997; Jackson 2011; Rauch and Trindade 2002).

Modeling the variation in firm-level information on destination markets through fixed entry costs is validated by extensive work on exporting. The importance of fixed entry costs of exporting, although prone to overestimation, has been confirmed in various studies (Das, Roberts, and Tybout 2007; Dickstein and Morales 2018). It is wellaccepted that the studies reflect imperfect information. Authors have extended the standard framework to allow for product-specific fixed entry costs (for multiproduct firms) and market-specific fixed entry costs, which are, on average, higher for advanced markets. The impact of fixed entry costs on firm entry is confirmed by the fact that the increases in exports that follow lower sunk costs tend to be through new firm entry (the extensive margin) rather than through an increase in export value of existing exporters (the intensive margin).

The identification of firm-market fixed entry costs is an important consideration for South Asian firms, where years of regional nonengagement have led to narrow and shallow business networks in some country pairs. However, given the prevalence of diverse communities and the migration that occurred particularly around the time of partition, it is highly likely that there are large differences among national firms in knowledge connectivity (and hence sunk entry costs) compared to communities and markets across national boundaries.

The approach used here is consistent with the work of Wagner and Zahler (2015), which allows for random entry costs and shows that a less productive firm with a lucky draw of a low fixed entry cost could enter a new destination ahead of a more productive

firm with an unlucky draw of a high fixed entry cost. Empirical work (Castro et al. 2016) for Chile has found heterogeneity in fixed export costs across firms. The work also found that the export decision incorporates both fixed export costs and productivity, allowing for the presence of high-productivity nonexporters (facing high fixed export costs) and low-productivity exporters (facing low fixed export costs). Additional work tries to capture variation in the available information across firms and finds that larger firms have more information than small firms, regardless of export experience (Dickstein and Morales 2018).6

Variation in uncertainty at the firm level is related to variation in information and the level of connectedness. In its simplest form, uncertainty can be reduced by obtaining information, implying that firms that face high uncertainty about a destination face high sunk fixed entry costs to resolve this uncertainty. There are different types of uncertainty—demand, policy, exchange rate, political, security—and they all can apply to the host or the home country. Interest in uncertainty has increased because of the growth in trade policy uncertainty since the global financial crisis of 2008, along with the ability to create empirical proxies for uncertainty using panels of firm-level outcomes, online news databases, and surveys. Measures of country- and global-level policy uncertainty using textual analysis of newspapers have proved accurate in capturing relevant events (Baker, Bloom, and Davis 2016). Many studies find evidence that high policy uncertainty at the country level undermines economic performance because firms delay or forgo investments and hiring, productivity-enhancing factor reallocation is slowed, and consumption expenditures are delayed (Bloom 2014; Caldara et al. 2019).

Other work has estimated uncertainty variation at the firm level, measured as political risk using textual analysis of firm investor updates (Hassan et al. 2019) and as the absolute value of foreign sales forecast errors (Chen et al. 2020). Firms may respond passively to uncertainty through the real options approach,7 which causes firms to assume a “wait and see” attitude and postpone their investment decisions. Alternatively, or additionally, they may take an active approach by engaging in activity to reduce firm-level uncertainty, for example, increasing lobbying in the United States (Hassan et al. 2019; Kost 2019) and entering foreign markets to acquire information and resolve uncertainty (Chen et al. 2020).

The role ascribed here to firm-level knowledge connectivity is captured in other fields using different terminology. The business management literature argues that a firm that intends to engage in foreign activities suffers a knowledge deficit about the foreign market, its players, and the rules (implicit and explicit) of the operating environment—sometimes called a liability of foreignness (Johanson and Vahlne 2009). A related management concept that gets at varying degrees of foreignness is psychic distance, which refers to the factors that make it difficult to understand foreign environments, including differences in language, culture, business practices, and industrial development. Regional engagement will require knowledge acquisition and learning about regional markets to overcome uncertainty and better understand the opportunities those markets offer. The extent of this required learning will depend on the psychic