FLEXIBILITY AND PRODUCTIVITY: TOWARD THE UNDERSTANDING OF FIRM HETEROGENEITY

We document four new stylized facts using Chinese firm-level data to show that the standard single-attribute model of trade, in which firms only differ in productivity, must be augmented with an additional layer of heterogeneity to match the facts. To match the evidence, a model requires heterogeneity in flexibility, namely, the ability to introduce new varieties in a destination at low costs. We calibrate our model and find suggestive evidence of a trade-off between productivity and flexibility. Furthermore, we show that ignoring firm flexibility causes a large underestimation of the welfare effects of trade.