Relational TradeEvidence from the United States

Fariha Kamal Heiwai Tang

US CensusJohns Hopkins University and CESIfo

July 20, 2015CESIfo Summer Institute

Any opinions and conclusions expressed herein are those of the authors and do

not necessarily represent the views of the U.S. Census Bureau. All results have

been reviewed to ensure that no confidential information is disclosed.

Incomplete Contracting in Global Sourcing

I Firms sign formal contracts to enforce actions.

I The world is complicated and unpredictableI contingencies are not contractible ex ante; outcomes are

observable but not verifiable ex post;I → Severe hold-up and moral hazard;I → Ex ante underinvestment.

I The trade literature has explored vertical integration as asecond-best solution to hold-up problems

I Antras, 2003; Antras and Helpman, 2004; Nunn and Trefler,2013; Antras and Chor, 2013; Antras, 2015, among others.

Informal Agreements and Repeated Interactions

I Unwritten code and trust are important for business.

I Buyers and sellers expect repeated interactions.

I Future profits from joint production can induce parties to takeactions that are profitable for both parties in the long run.

I Huge theoretical literature on relational contracts (i.e., informalagreements sustained by the future value of the relationship)

I see reviews by Macleod, 2007 and Malcomsom, 2012; seminalpapers by Baker, Gibbons, and Murphy 2002, and Levin, 2003,among many others.

I These informal agreements and repeated interactions are largelyoverlooked in the trade literature, both theoretical and empirical(exceptions: Antras and Foley, 2014; Macchiavello and Morjaria,2015)

What do GVC experts say?

I Gereffi, Humphrey, and Sturgeon in The governance of global valuechains (2005):

I “Recognizing the importance of transaction costs need notlead to the conclusion that complex and tightly coordinatedproduction systems always result in vertical integration.Rather, asset specificity, opportunism, and coordination costscan be managed at the inter-firm level through a variety ofmethods.”

I Hughes (2000), Henderson et al. (2002) and Dicken et al. (2001):I The key insight is that coordination and control of global-scale

production systems, despite their complexity, can be achievedwithout direct ownership.

Five GVC Governance Types (Gereffi, et al. (2005))

Figure 1 Five global value chain governance types.

89

This Paper

I Develop a relational contracting model to spell out the conditions,under which first-best investments and outcomes are actuallyachievable (i.e., how relational contracts can circumvent contractualproblems).

I Today’s focus: discount factor and headquarter intensity.

I Antras-Helpman (2004) meets Baker-Gibbons-Murphy (2002).

I Shed light on when informal agreements and formal contracts (i.e.,optimal organizational modes of production) are complements andsubstitutes.

I Preliminary: Use confidential US importer-exporter matchedtransaction-level data (1992-2011) to

I verify the main predictions about the prevalence of differentorganizational modes of trade.

I explore how a sudden increase in input suppliers from Chinaaffect the pattern of global sourcing pattern.

Importance of Relational Trade

Average Number of Sellers/Buyer

% Arms-Length Related PartySpot 8 3Relational 31 57

% Arms-Length Related PartySpot 17 9Relational 23 51Source: US Census LFTTD (Average across 1992-2011)

Relational Age >=5 years

Relational Age >= 3 yearsShare in Total US Imports

Rising Importance of Intra-firm Trade

-.02

0.0

2.0

4.0

6

1995 2000 2005 2010year

mean lowhi

Time trend, controlling for country and sector (HS2) fixed effects.

Preview of the ModelI Antras-Helpman (2004) meets Baker-Gibbons-Murphy (2002)

I features totally incomplete contracts in global sourcing,repeated interactions, relational contracts.

I The headquarter in the North chooses one of the four organizationalmodes (SO, RO, SV, and RV) to outsource input production to asupplier in the South, depending on the relative importance ofheadquarter intensity of final-good production and interest rates.

I When both parties are sufficiently patient (i.e., interest rates arelow) and production is not too headquarter- orcomponent-intensive, firms are more likely to rely on repeatedinteractions to sustain first-best investments.

I With very low interest rates, arms-length trade prevails.

I For relatively component-intensive sectors, relational contracts andintegration are substitutes. For relatively headquarter-intensivesectors, relational contracts and integration are complement.

I When interest rates are very high, spot relationships are the optimalproduction arrangements (the analysis is back to Antras andHelpman (2004)).

Main Theoretical Arguments in One Graph

Relational Integration (RV)

Relational Outsourcing (RO)

Spot Integration (SV) Spot Outsourcing

(SO)

r

Headquarter intensity 0.5 1

Preview of the Empirical Analysis (Preliminary)

I For exporters from high interest-rate countries (proxied by politicalrisks or rule of law): positive relationship between headquarter(capital and skill) intensity and the share of imports through spotintegration.

I For exporters from low interest-rate countries: a positiverelationship between headquarter intensity and the share ofrelational integration.

I An increase in suppliers from China reduces the average relationshipage (i.e., probability of discontinuation) under outsourcing, butincreases that under integration.

I These effects are stronger for headquarter-intensive imports.

Literature Review (Incomplete)

1. Organization Modes of Global SourcingI Theory: Antras (2015) contains a comprehensive overview of

his contributions and subsequent extensions.I Empirical Work: Nunn and Trefler (2008, 2013), Bernard et al.

(2010), and Dez (2010) (survey by Antras and Yeaple (2014)).several firm-level studies

2. Relational ContractsI Theory: Bull (1987), Klein (1995, 2000) Baker, Gibbons, and

Murphy (1994, 2002), Halonen (2002), Levin (2003), Halac(2012), etc. (surveys by Macleod, 2007 and Malcomsom,2012)

I Empirical Work: Survey by Gil and Zanarone (2015).

3. Relational Contracting in TradeI Antras and Foley (2014); Macchiavello and Morjaria (2015);

Defever, Fischer and Suedekum (2015); Monarch andSchmidt-Eisenlohr (2015).

Road Map

I Model (One-shot then repeated game)

I Data

I Empirical Analysis (Preliminary)I Cross-sectionI Time-series at the importer-exporter pair level, taking import

competition from China as exogenous.

Demand

I Our assumptions of preferences, market structure, and firmheterogeneity follow Melitz-Chaney.

I All firms face consumers in each country and period, with the sameconstant-elasticity-of-substitution preferences over differentiatedproducts. A firm’s demand:

q = EPσ−1p−σ, σ > 1

I E is the total expenditure for the sector; P is the sector-specificprice index; p and q stand for price and quantity.

I σ is the constant elasticity of substitution between different varieties(brands) within a sector.

Production

I Each period, production requires the non-cooperative,non-contractible investments by a (downstream) headquarter firm(H) in the North and a (upstream) input supplier (M) in the South.

I Production function of a variety:

q = θ

(m

1− η

)1−η (h

η

)η

,

θ is productivity of the joint production unit, exogenously endowedto H, assumed to be transferred across border.

I Intermediate inputs (m) produced by M and headquarter services(h) produced by H.

I Final-good sectors differ in η ∈ (0, 1), headquarter intensity.

I A production asset can be owned by H or M.

I The property-rights approach: vertical integration implies that Hholds ownership of the asset.

Organization Choices and Bargaining

I Consider two organization mode: (spot) foreign outsourcing (O)and (spot) foreign vertical integration (V ); fk the sunk (fixed)costs; fV > fO .

I Contracts are incomplete.

I Symmetric Nash Bargaining: bargaining power equal to 1/2 foreach party.

I At the bargaining stage, the outside option of each party and thusthe de-facto shares of joint surplus depends on the organizationalform (V or O).

I Under Outsourcing:I Outside options for both H and M are 0.

I Under Integration:I If bargaining fails, H can fire M, seize M’s inputs to complete

the production with another plant.I H’s outside option is δR < R, while M’s outside option is 0.

Investment Decisions

I Denote by βk H’s expected share of the joint surplus underintegration, and (1− βk ) the expected share for M, for k ∈ {O,V }

βV =1 + δ

2> βO =

1

2.

I H’s maximization problem:

maxh,t

βkp(q)q − wNh− wN fk − t

s.t. t + (1− βk ) p(q)q − τwSm ≥ 0

m∗ = maxm

(1− βk ) p(q)q − τwSm− t,

I t is the ex-ante transfer from M to H, which makes M indifferentbetween teaming up with different downstream buyers.

Choosing Optimal Spot Organization Modes

I H chooses the production mode to maximize her objective asfollows:

π∗ (B, η, θ) = maxk∈{V ,O}

{AΓk

(αθ

c (η)

) α1−α

− wN fk

}

H’s choices depend on the slopes of Γk and the fixed costs fk .

c (η) = (wS )1−η (wN )

η

I The ratio of profitability:

ΓV

ΓO=

1− α2 (1 + (2η − 1) δ)

1− α2

[(1 + δ)η (1− δ)(1−η)

] α1−α

I Antras (2003, 2005, 2015):

I ΓVΓO

is decreasing in η;

I a unique η∗ < 1 exists, such that ΓVΓO

> 1 for η > η∗;

Relational Contracts

I Consider relational contracts by extending the model in arepeated-game setting.

I Solve the model backward (rational expectation equilibrium) todetermine the optimal organization mode at t=1.

I Assumptions:I Both M, H and the asset (i.e., zero depreciation) live foreverI Discount next-period profits by (1 + r)−1.I Investment only affects production in the current period and

does not affect production in future periods.

I Both parties continue to cooperate unless one side of therelationship reneges from the informal agreements, after which bothparties forgo cooperation indefinitely.

I We solve for the trigger-strategy equilibrium that maximizes thefirm’s expected profits, subject to the supplier’s participation (IR)and incentive-compatibility (IC) constraints.

Relational Contracts (cont’)

I What affects the sustainability of relational contractsI the interest rate;I the one-time gain and long-term loss due to reneging from the

informal agreements;I the firm’s expected profits from the relationship.

I Importantly, in addition to organizational form, using relationalcontracts can also influence the upstream supplier’s actions.

Timing of Events

I t0 : D chooses the organizational mode (V or O) and whether touse relational contracts when forming a production relationship withM:

I Spot contracts: offers M an up-front payment (t).I Relational contracts: offers M a compensation package that

constitutes an up-front payment (t) and a promised futurepayment (b), conditional on investing at the implicitlyagreed-upon level.

I t1 morning : H chooses h and M chooses m simultaneously inanticipation of the optimal and sustainable production mode.

I t1 afternoon : Observing m chosen by M, H decides whether tohonor the relational contracts by paying b, if it was chosen at t0.

I t2 : If either party reneges at t1 afternoon, the game gets into thepunishment phase and the spot (Antras-Helpman) equilibriumprevails indefinitely. If both parties choose to honor the relationalcontracts, the events at t1 and t2 will repeat indefinitely until oneparty reneges.

Decisions at t0

Downstream buyer (D)

Integration

Outsourcing

1 Renege and play spot integration forever

2. Relational integration

3. Renege and play spot outsourcing forever

4. Relational outsourcing

wNfO

wNfV

Reneging Temptations

I Let us show how the first-best investments (m∗, h∗) and profits canbe attained without formal contracts

I Pre-requisite: sufficiently low interest rates.

I Let us denote the first-best profits by πfi for i ∈ {H,M}. The

following IC constraints need to hold:

M : (b− wSm∗)

(1 +

1

r

)≥ πd

M +πpM

r,

H :(

πf − wNh∗ − b

)(1 +

1

r

)≥ πd

H +πpH

r,

I f , p, and d stand for first-best, punishment, and deviation,respectively.

I πdi is the one-time profit for party i if he deviates from the

relational contract.

First-best Investments

I Ex ante, H designs a two-part contract (with t and b) to induce thefirst-best action by M.

I To solve for the level of bonus, b, which sustains the first-bestinvestments in equilibrium, we need to first solve for πf

i , πdi , and

πpi for both i = H,M:

I The first-best investment levels:

{h∗,m∗} ≡ arg maxh,m

R (m, h)− wNh− wSm

=

Aη[αθαw

α(1−η)−1N w

−α(1−η)S

] 11−α

,

A (1− η)[αθαw

−αηN w

αη−1S

] 11−α

Reneging Investments

I

maxm{(1− βk )R (m, h)− wSm}

I Given h∗, the level of M’s reneging investment can be solved:

md = arg maxm{(1− βk )R (m, h∗)− wSm}

= A (1− η) (1− βk )1

1−α(1−η)

[αθαw

−αηN w

αη−1S

] 11−α

< m∗

I Given m∗, H’s reneging level of investment can be solved:

I

hd = arg maxh{βkR (m∗, h)− wNh}

= Aηβ1

1−αη

k

[αθαw

−α(1−η)S w

α(1−η)−1N

] 11−α

< h∗

The One-time Profits after Reneging

I The corresponding profits for H and M for deviating from thefirst-best levels are

M : πdM = (1− βk )

11−α(1−η) A

[θαw

−ηN w

−(1−η)S

] α1−α

[1− α (1− η)]

H : πdH = β

11−αη

k A[θαw

−ηN w

−(1−η)S

] α1−α

(1− αη)

I Recall that the per-period joint profit in the punishment phase isjust the profit in the spot (AH) equilibrium

πpk ≡ πp

Uk + πpDk = AΓk

(αθ

c (η)

) α1−α

− wN fk , for k ∈ {O,V }

The interest rate

I Substituting πdU and πp

k into M’s IC (non-reneging) constraint

r ≤ (b−wSmf )−πp

U

πdU−(b−wSmf )

I Substituting πdU and πp

k into D’s IC (non-reneging) constraint

r ≤ (πf −wNh−b)−πpD

πdD−(πf −wNh−b)

I b will be chosen by D to balance the benefits between H and M.

I Setting the RHS of the two IC constraints equal yields b∗, implying

r ≤ r f ≡ Loss

Gain,

I Loss =(πf − wNh− wSm

f)−(πpU + πp

D

)I Gain =

(πdD + πd

U

)−(πf − wNh− wSm

f).

Insights

time

πi

πRi= π*

i

πdi

Gain

Loss

πpi

t t+1

Punishment Phase

Optimal Organization Modes Revisited

I We can further express r fk (η) in terms of the parameters as

r fk (η) =(1− α)−Φpk (η)

Φdk (η)− (1− α)

Φpk (η) ≡((1 + δk )

η (1− δk )(1−η)

2

) α1−α (

1− α

2(1 + (2η − 1) δk )

)

Φdk (η) ≡(

1− δk2

) 11−α(1−η)

[1− α (1− η)]+

(1 + δk

2

) 11−αη

(1− αη) .

δV = δ for integration and δO = 0.

The Relation between r f (η) and η

I r fO (η) and r fV (η) are inverted U-shaped with respect to η.r fO (η) attained its maximum value when η = 1

2 , while r fV (η)attained its maximum value at η > 1

2 .

I Intuition: the first-best actions are more likely to be sustained usingrelational contracts for an intermediate range of headquarterintensity.

I Investment by either party is relatively important.

I Reason: temptation to renege by H (M) is increasing (decreasing)in headquarter intensity.

I Coordination can be more easily sustained if the contribution ofjoint production is relatively balanced.

Lemma

The range of the interest under which relational outsourcing or relationalintegration are sustainable takes the inverted U-shaped againstheadquarter intensity of production. In other words, for intermediateheadquarter-intensive sectors, the range of interest rate below whichrelational trade is sustainable is the widest.

What happens after either party reneges?

I When the interest rates are higher thanr f (η) = max

{r fO (η) , r fV (η)

}, relational contracts are not

sustainable.

I Firms expect to play one-shot games every period, back to theanalysis of Antras and Helpman (2004).

Punchline of the Model

Relational Integration (RV)

Relational Outsourcing (RO)

Spot Integration (SV) Spot Outsourcing

(SO)

r

Headquarter intensity 0.5 1

When are integration and relational contractscomplements?

I When is r fk (η) maximized, given η?

r fk (η) ≡(Loss

Gain

)k

, k ∈ {O,V }

LossVLossO

=(1− α)−ΦpV (η)

(1− α)−ΦpO (η),

which is decreasing in η, as according to Antras (2003).I So it’s not about maximizing loss; how about minimizing gains in

the reneging period?GainOGainV

I In h-intensive sectors, under integration, M has lower de factobargaining power under integration than outsourcing.

I Even though H he has higher bargaining power, he has moreincentive to invest closer to the first best in headquarter-intensivesectors. So the reneging investment level is not too different fromthe first best.

Incorporating the Model into the Melitz FrameworkI Embed the above relational contracting model in the PE version of

Melitz (2003).I H chooses the optimal production mode to maximize joint surplus:

π∗ (B, η, θ) = maxk∈{RO,SO,RV ,SV }

r−1πk (B, η, θ) .

I Imposing Pareto distribution of firm productivity, the share ofintra-firm trade in spot equilibrium:

ShSV =ΓV /ΓO[(

θVθO

)κ−σ−1− 1

]+ ΓV /ΓO

,

where

θV

θO=

[(fVfO− 1

)× 1− (wN/wS )

−(σ−1)(1−η) /ΓO

ΓV /ΓO − 1

] 1σ−1

,

I and κ captures the dispersion of the productivity distribution.

The Prevalence of Intra-firm Trade Revisited

I Repeating similar steps for three levels of interest rates:

SO RV SV

SO RO RV

For intermediate interest rates:

For low interest rates:

For high interest rates:

SO SV

η

η

η

Hypothesis 1

I With sufficiently high interest rates, the problem is reduced to theone with spot organization modes only, as both relationaloutsourcing and relational integration are unsustainable.

I In sufficiently headquarter-intensive sectors, the more productivebuyers choose spot integration while the less productive ones choosespot outsourcing.

I There is no relation between the length of the relationship andheadquarter intensity of production.

Hypothesis 2

I With an intermediate range of interest rates, relational contracts arefeasible for the more productive firms operating in the intermediateheadquarter-intensity sectors.

I For sufficiently headquarter-intensive sectors, the more productivebuyers choose spot integration while the less productive one choosespot outsourcing.

Hypothesis 3

I With sufficiently low interest rates, relational contracts are feasiblefor the more productive firms operating in the relativelyheadquarter-intensive sectors.

I All firms, regardless of productivity, choose relational outsourcing asthe optimal production mode in intermediate headquarter-intensivesectors.

I For the most headquarter-intensive sectors, the more productivebuyers choose relational integration while the less productive oneschoose relational outsourcing.

Data

I Linked/Longitudinal Foreign Trade Transactions Database (LFTTD)from the U.S. Census Bureau.

I A confidential database that contains detailed information (value,quantity, and date of the transaction) for the universe of importtransactions at the firm-product (10-digit HS) level.

I The novel feature: information about the foreign party involved foreach trade transaction.

I U.S. Customs Border Protection (CBP) requires importers in theU.S. to report information about their foreign exporters, which canbe producers or intermediaries.

I A foreign exporter is uniquely identified by the ”Manufacturer ID”(MID), a required field on Form 7501, the form U.S. importers arerequired to fill out by the U.S. CBP.

I Period: 1992-2011.

Descriptive Statistics

Related Party Arms Length% of buyers 16 84% of sellers 14 86Sellers/buyer, mean 7.28 11.96Sellers/buyer, median 2 2Buyers/seller, mean 1.19 1.65Buyers/seller, median 1 1Share trade, top 10% buyers (%) 95 91Share trade, top 10% sellers (%) 96 88Log max/median imports 10.64 10.43Log max/median exports 13.38 12.74Share in total U.S. imports, % 47 53

Table 1. Descriptive Statistics, 2011.Overall

Source : Longitudinal Foreign Trade Transactions Database. Exclude Mineral Imports Only.

Relationship Age (Country Ranking)

Japan 5.34 Japan 3.50Malta 4.87 Zimbabwe 3.42Switzerland 4.85 Switzerland 3.39Ireland 4.71 Taiwan 3.30Germany 4.67 Germany 3.15Belgium 4.52 Lebanon 3.02Austria 4.37 Belgium 3.01Denmark 4.32 Thailand 2.97Mexico 4.30 Namibia 2.96Sweden 4.26 Algeria 2.94

Tunisia 1.05 Afghanistan 1.18Morocco 1.38 Senegal 1.21Cyprus 1.42 Azerbaijan 1.40Lebanon 1.56 Sierra Leone 1.44Ukraine 1.57 Uzbekistan 1.47Latvia 1.77 Nigeria 1.49Vietnam 1.90 Cayman Islands 1.49Romania 2.19 Georgia 1.51Lithuania 2.25 Niger 1.52Nepal 2.26 Guinea 1.53China 2.34 Botswana 1.54Source: Authors' computation based on the U.S. Linked/Longitudinal Foreign Trade Transactions (LFTTD) Database. Year = 2005.

Arms Length

Bottom 10 in terms of the weighted average age of relationship

Top 10 in terms of the weighted average age of relationshipTable 1: Average Duration of Importer-Exporter Relationships by Country

Related Party

Relationship Age (Industry Ranking - Top 5)

87: Vehicles other than railway or tramway rolling stock, etc. 7.46 80: Tin and articles thereof 5.7437: Photographic or cinematographic goods 7.22 14: Vegetable plaiting materials 5.1175: Nickel and articles thereof 6.48 67: Prepared feathers and down and articles made of 4.5930: Pharmaceutical products 5.16 88: Aircraft, spacecraft, and parts thereof 4.3592: Musical instruments 4.86 51: Wool, fine or coarse animal hair … 4.29

64: Footwear, gaiters and the like; parts of such articles 1.23 79: Zinc and articles thereof 2.2267: Prepared feathers and down and articles made of feathers 1.22 30: Pharmaceutical products 1.8514: Vegetable plaiting materials 1.21 87: Vehicles other than railway or tramway rolling stock 1.8441: Raw hides and skins (other than furskins) and leather 1.21 75: Nickel and articles thereof 1.8466: Umbrellas, sun umbrellas, walking sticks, … 1.07 37: Photographic or cinematographic goods 1.57

Related Party Arms LengthTop 5 in terms of Weighted Average Age

Table: Average Age of Importer-exporter Relationships by Sector

Related Party Arms LengthBottom 5 in terms of Weighted Average Age

Relationship Age (Industry Ranking - Bottom 5)87: Vehicles other than railway or tramway rolling stock, etc. 7.46 80: Tin and articles thereof 5.7437: Photographic or cinematographic goods 7.22 14: Vegetable plaiting materials 5.1175: Nickel and articles thereof 6.48 67: Prepared feathers and down and articles made of 4.5930: Pharmaceutical products 5.16 88: Aircraft, spacecraft, and parts thereof 4.3592: Musical instruments 4.86 51: Wool, fine or coarse animal hair … 4.29

64: Footwear, gaiters and the like; parts of such articles 1.23 79: Zinc and articles thereof 2.2267: Prepared feathers and down and articles made of feathers 1.22 30: Pharmaceutical products 1.8514: Vegetable plaiting materials 1.21 87: Vehicles other than railway or tramway rolling stock 1.8441: Raw hides and skins (other than furskins) and leather 1.21 75: Nickel and articles thereof 1.8466: Umbrellas, sun umbrellas, walking sticks, … 1.07 37: Photographic or cinematographic goods 1.57

Related Party Arms LengthTop 5 in terms of Weighted Average Age

Table: Average Age of Importer-exporter Relationships by Sector

Related Party Arms LengthBottom 5 in terms of Weighted Average Age

Relationship Age DistributionDistribution of pair age by related/unrelated party trade status, 2005

Regression Specification

Shict = αc + αt + βhi × Int rate + εict ,

I where i , c, and t stand for sector (HS2), country, and year,respectively. Shict stands for one of the following four measures –the share of imports that belong to SO, SV , RO, and RV at thecountry-sector-year level.

I H1: High interest rates: positive relationship between headquarterintensity and spot integration.

I H2: Intermediate interest rates: same but for an intermediate rangeof headquarter intensity, relational integration can be prevalent.

I H3: Low interest rates: a positive relationship between headquarterintensity and relational integration; and NO relationship betweenheadquarter intensity and spot integration.

I 2 exogenous measures at the country level to proxy for interestrates: political stability and rule of law.

Results - Organizational Forms, Interest Rates, FactorIntensity (Sector-Country Level)

(1) (2) (3) (4)Dep VarMeasure of Interest Rates pol stability rule of law pol stability rule of lawskill x low r -0.0169 -0.0235 0.107*** 0.0783**

(0.012) (0.016) (0.038) (0.036)

skill x med r -0.00395 -0.00867 0.0908** 0.115***(0.019) (0.014) (0.038) (0.043)

skill x high r 0.0530 0.0378 0.0161 0.0867***(0.038) (0.024) (0.044) (0.033)

capital x low r 0.0190*** 0.0192*** 0.0625*** 0.0550***(0.006) (0.007) (0.014) (0.014)

capital x med r 0.0417*** 0.0333*** 0.0551*** 0.0621***(0.009) (0.007) (0.016) (0.016)

capital x high r 0.0665*** 0.0517*** 0.0573* 0.0706***(0.025) (0.015) (0.034) (0.021)

Fixed Effects

N 47579 47579 55662 55662adj. R-sq 0.31 0.31 0.17 0.17

Table: Relational Contracts, Interest Rates, and Factor Intensity

Notes: Sample excludes intermediaries and importers born < 1992. Standard errors clustered by sector. Significance at *10%, **5%, ***1% levels.

Country, Year

Imp Shr of SV Imp Shr of RV

Results - Age, Interest Rates, Factor Intensity(Sector-Country Level)

Sample I O I OProxy for interest rates Rule of Law Rule of Law Pol Stability Pol StabilityExpected Sign of Proxy(r) + + + +Expected Sign of the Interaction + - + -log (Skill Intensity) 0.899*** -0.369*** 0.939*** -0.477***

(0.219) (0.129) (0.228) (0.139)

log (Skill Intensity) x Proxy_r 0.0399 -0.261*** -0.114 -0.175**(0.123) (0.092) (0.135) (0.083)

log (Capital Intensity) 0.405*** -0.0999** 0.437*** -0.154***(0.091) (0.046) (0.090) (0.047)

log (Capital Intensity) x Proxy_r 0.0322 -0.126*** 0.00211 -0.0821***(0.051) (0.029) (0.052) (0.028)

Proxy_r 0.296** -0.109 0.242 -0.124(0.133) (0.087) (0.149) (0.079)

Fixed EffectsObservations 58093 97247 58148 97415Adjusted R-squared 0.08 0.11 0.08 0.11Notes: Observations are at the sector-country level. Standard errors clustered at the sector (HS2) level are reported in the parentheses. Significance at *10%, **5%, ***1% levels.

Table: Average Age of Relationships, Interest Rates, and Factor Intensity

Can increasing outside option of US buyers contribute tothe rise of its intra-firm imports?

I Consider now both H and M have higher outside options due toincreased opportunities to work with alternative partners.

I Denote εM ∈ [0, 1] as the degree of specificity of M’s inputs. M canrecoup only 1− εM of the marginal product of his input, ∂R

∂m , byworking with another downstream firm on the market.

I H expects to recoup 1− εH ≤ 1 of ∂R∂h .

I The ex ante (perceived) share of revenue for U and D underoutsourcing are

βMO = 1− εM

2; βH

O = 1− εH2

.

I Under integration, the perceived share of revenue for M will need tobe adjusted to reflect the ability of H to seize M ′s asset in the caseof failed bargaining. The (perceived) share of revenue for M and Hunder integration are:

βMV = 1− (1 + δ) εM

2; βH

V = 1− (1− δ) εH2

Can increasing outside option of US buyers contribute tothe rise of its intra-firm imports?

ΓV

ΓO=

(1− αη

(1− (1−δ)εH

2

)− α (1− η)

(1− (1+δ)εM

2

))(1− αη

(1− εH

2

)− α (1− η)

(1− εM

2

))×

(1− 12 (1 + δ) εM

1− 12 εM

)1−η (1− 1

2 (1− δ) εH

1− 12 εH

)η α

1−α

∂

∂ (1− εH )ln (ΓV /ΓO) ≤ 0

∂

∂ (1− εM )ln (ΓV /ΓO) ≥ 0

When the specificity of the H’s investment becomes lower due to athicker input market as a result of globalization, integration shouldbecome less attractive, inconsistent with the observed upward trendof intra-firm trade.

But the predictions are overturned with relational contracts

I

RV

RO

SV

SO

r

η

Increasing number of sellers per buyer, esp after 2001

Average Number of Sellers/Buyer

% Arms-Length Related PartySpot 8 3Relational 31 57

% Arms-Length Related PartySpot 17 9Relational 23 51Source: US Census LFTTD (Average across 1992-2011)

Relational Age >=5 years

Relational Age >= 3 yearsShare in Total US Imports

Increasing Share of Chinese Imports, esp after 2001

Chinese Import Share

Regression Specification (Sector-country level)

Ageict = δMChit + γMCh

it × hi + αi + αc + αt + ξict ,

I where i , c, and t stand for sector (HS2), country, and year,respectively. Ageict is the (weighted) average age of theimporter-exporter relationship.

I δ < 0; γ < 0 for outsourcing; δ > 0; γ > 0. for related party trade.

I We estimate the following linear specification using pair-level data:

Results - Chinese Trade Shocks and Relationship Age

Table: Chinese shocks, integration, relational trade (sector-country-year level)Dependent Variable

All Integrated OutsourcingChinese Shock 0.884 1.562 -1.526**

(0.683) (1.151) (0.717)Chinese shock x Skill Int. 1.383* 3.300*** -2.089**

(0.811) (1.229) (0.804)

Capital Int. 0.615 1.131* -0.546(0.399) (0.589) (0.364)

Fixed Effects

Observations 99740 56824 95891Adjusted R-squared 0.28 0.23 0.16

Country, Sector and Year

Notes: The Chinese shock is mesaured as Imp/Total US Imp, sector-year level. Observations are at the sector-country-year level. Exclude Intermediaries, One-time Pairs, Importers Born < 1992. Standard errors clustered at the sector (HS2) level are reported in the parentheses. Significance at *10%, **5%, ***1% levels. Sample excludes intermediaries, one-time pairs, and importers born < 1992.

Weighted Avg Pair Age (Exclude Ch. Imp)

Regression Specification (Importer-exporter-pair level)

Dropmnit = ηMChit + φMCh

it × hi + αm + αn + αi + αt + ζmnit ,

I where m, n, i , and t stand for importing firm, exporting firm, sector(HS2), and year, respectively. Dropmnit = 1 if the trade relationshipbetween firms m and n is discontinued between t − 1 and t, 0otherwise.

I η > 0; φ < 0.

Results - Chinese Trade Shocks and RelationshipTermination

Dep VarSample All Integrated OutsourcingChinese shock (at sector-year level) 0.062 0.202*** 0.033

(0.048) (0.038) (0.064)

Chinese shock x Capital Int -0.187*** -0.070 -0.185***

(0.015) (0.044) (0.016)

Skill Int -0.216*** 0.082 -0.226***(0.064) (0.082) (0.077)

Fixed Effects

Observations 11,203,061 1,923,821 9,279,240Adjusted R-squared 0.19 0.3 0.17

Drop_ijct

Notes: Observations are at the buyer-seller pair level. Standard errors, clustered at the importer level, are reported in the parentheses. Significance at *10%, **5%, ***1% levels.

Table: Drop rates and the Chinese shock (importer-exporter-pair level)

importing firm, exporting firm, sector and year

Conclusions

I One of the first to examine how relational contracts play a role inshaping international trade.

I Develop a relational contracting model to show that low-interestrates and an intermediate level of headquarter intensity arefavorable for relational contracts to alleviate contractual problems.

I Enrich existing models on vertical integration, in particular, Antrasand Helpman (2004), to study when integration and relationalcontracts are complements.

I Preliminary evidence from US importer-exporter matchedtransaction-level data confirm the model predictions, and show thatincreasing supply of Chinese input producers may explain theupward trend of imports within firm boundary.

APPENDIX

Non-zero Outside Options

I M chooses the (privately) optimal level of m:

1

2

(∂R

∂m− (1− εM )

∂R

∂m

)+ (1− εM )

∂R

∂m= wS .

I H chooses the optimal level of h, which satisfies the following

1

2

(∂R

∂m− (1− εH )

∂R

∂h

)+ (1− εH )

∂R

∂h= wN .