April 13, 2011

New Respect for the Middleman

New research provides the first empirical evidence that quantifies the role of the so-called middleman in developing and expending international trade — data that could play an important role in US trade policy.

Rebecca McReynolds

President Obama’s initiative to double US exports by 2015 raises more questions than it answers, says Amit Khandelwal, a Chazen senior scholar and assistant professor of finance and economics at Columbia Business School. Chief among those questions is the role of government in boosting exports, particularly among small- and medium-sized companies, he says. A new paper coauthored by Khandelwal, “The Role of Intermediaries in Facilitating Trade,” provides the first empirical evidence that quantifies the role of the so-called middleman in developing and expanding international trade — data that can play an important role shaping US trade policies, he says.

“There is an active debate going on now about how the Obama administration plans to achieve its goal,” says Khandelwal, who coauthored the paper with Shang-Jin Wei, director of the Chazen Institute and professor of finance and economics at Columbia Business School, and JaeBin Ahn, a Ph.D. candidate in economics at Columbia University. First, there is the question of what exactly Obama wants to double: the number of exports or simply the dollar value of total exports. Since 1 percent of US exporters make up 80 percent of the total volume, this distinction is critical when developing government policy, says Khandelwal.

If the goal is to double the dollar amount, that could be met by encouraging the Export-Import Bank of the United States to guarantee more loans which would, for example, help Boeing sell more planes abroad, Khandelwal says. “That is very different from a policy that would promote exports for small- to medium-sized firms,” he says. “Their issue is often identifying the potential buyers, and that’s where intermediaries come in.”

Power in Numbers

Khandelwal and his coauthors focused their research on China, dividing the country’s exporters into two groups: companies that export their goods directly into foreign markets, and companies that use intermediaries to manage their trade. Among the study’s key findings is that intermediaries can help boost exports by aggregating products from smaller companies that don’t have the internal resources to identify and tap foreign markets on their own. They can also help businesses of any size access hard-to-reach markets.

While the study looked exclusively at China, its results are applicable across borders because all exporters, regardless of their homeport, face the same barriers when entering foreign markets. For example, a company that wants to export a packaged food product needs to understand each country’s product safety standards, import regulations, and tariff structures. For most developed markets, such as Europe, that information is readily available on the Internet. Tapping into the growing markets of China and India, though, can be much more difficult because the information is either hard to find or subject to change, Khandelwal says. “A food import-export company can be a specialist in that area, so it may be worthwhile to pay for that intermediary,” he says.

Small Markets, Big Results

The research also identified a very robust relationship between intermediary export shares and markets that are smaller and have higher trade costs. For example, countries that are farther away, smaller in size, and require more documents for importing (a measure of fixed costs of trade) receive a larger fraction of their Chinese exports through intermediaries. At the same time, market share for intermediaries increases in direct proportion to local tariffs. This evidence strongly supports the hypothesis that intermediaries facilitate trade to markets that are more difficult to access, Khandelwal says.

Finally, the study shows a direct link between the size of the firm and the use of trade intermediaries, implying that small firms can, and do, access foreign markets through intermediaries even when they aren’t large enough to cover the fixed costs of direct exporting. And once small firms gain access to foreign markets, they can develop their own contacts there, enabling them to become direct exporters in the future.

In his address to the US Export-Import Bank in March, President Obama listed better promotion of small- and medium-sized business as one of the key planks of his foreign trade initiative. Understanding the importance of intermediaries in helping smaller firms export is the first step in doing that, Khandelwal says. “Our research shows that large firms can access markets on their own because they have the resources to do it, but smaller firms don’t,” he says. “The US government could create policies to increase the types of firms that can facilitate exports.”

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