Middlemen Lead the Way on Trade

New research shows how intermediaries play a key role in facilitating the movement of goods across the globe.
September 30, 2011 | Research Feature
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Virtually every country is interested in increasing its exports. President Obama has declared an ambitious goal of doubling US exports in five years. While the Chinese GDP growth numbers are impressively high, its export growth is even more eye-popping, doubling consistently every three years over the last decade. How does it do it, and how can other nations emulate China’s success?

Until about a decade ago, experts viewed international trade through the lens of countries trading with each other: the United States traded its airplanes for T-shirts. Of course, individual companies, not countries, are the entities that actually do the trading and this casts exporting not in terms of nation-to-nation trade, but in terms of firm-to-firm trade. Access to customs data has enabled researchers to analyze firms’ participation in international markets, and researchers consistently find that only a fraction of firms in any country appear on these customs documents. The traditional explanation for why such a small fraction of firms export is that exporting is costly, so only the most efficient, largest, and best-run firms are able to export.

A contrarian view is that many more firms may actually participate in exporting, but that they are “hidden” because they sell products indirectly through intermediaries who then re-sell them abroad. Such firms would not appear in customs records because they use the intermediary as a export conduit. In particular, smaller and midsize firms without the resources to export directly may choose to use intermediaries to facilitate selling their products abroad.

Intermediaries are often better able to navigate the thicket of obstacles than a direct exporter might be able to on its own, says Professor Amit Khandelwal. “It’s expensive to set up a distribution network. Firms must establish the right contacts abroad, and, especially in developing countries, can face considerable bureaucratic hurdles,” he says. “Intermediaries can become specialists, for example, accessing the export market for India because they know how the Indian bureaucracy works, and they know who on the other side — maybe another middle-man — can get the products to market quickly.”

Middlemen have often been vilified, says Khandelwal, sometimes rightly so. “Fair trade advocates have pointed out that when intermediaries buy from farmers and sell to retailers and take their cut, they use their market power to force prices down in countries where there are very few middlemen.” But some sort of intermediary is necessary for small producers to access markets; retailers are unlikely to make individual deals with 10,000 different cotton farmers, for example, making intermediaries a crucial link that provides farmers and retailers access to each other.

If intermediaries do play a significant role in facilitating trade, that fact should inform how any nation frames its efforts to increase exports. With this policy context in mind, Khandelwal and Professor Shang-Jin Wei looked at the evidence for whether intermediaries are helping to access markets more successfully than producers and manufacturers would be able to on their own.

Focusing on China, the world’s largest exporter, the researchers used electronically-gathered customs-declaration data. While all goods leaving the country must be reported, customs forms don’t always indicate whether the originating firm is a direct exporter or an intermediary. China’s former practice of central planning spawned a host of very descriptive company names that identify firms’ main activities. The descriptors allowed Khandelwal and Wei to infer type of firm by, for example, identifying intermediaries as firms with phrases ”trading company,” or “importer/exporter” in their names.

Imprecise though this may seem — many firms that began as exporters may have shifted over the years to become intermediaries, or vice versa — this allowed the researchers to separate products leaving the country into two groups: products shipped by exporters and those handled by trading companies, from which the researchers estimated the percentage of products sold by intermediary firms. (Further research conducted after this paper uses more detailed data and confirms these general trends.)

The researchers found that intermediaries were most concentrated in markets that were difficult to penetrate — those that were either costly because of distance, bureaucratic hurdles, or underdeveloped infrastructure. The Chinese firms that the researchers classified as direct exporters, for example, appear to have easy access to close markets like Japan, Hong Kong, and Singapore, and even to large markets like the United States. In the case of Japan, some cultural similarities in addition to geographical proximity make for ease of direct exporting, while the US market is so large that the payoff for trading here far offsets the resources required to enter the market. Whereas when products moved from China to Turkey, trading companies were more important, suggesting that Turkey is a difficult market for China to penetrate. Also consistent with theories about direct and indirect exporting, the researchers found that a relatively small number of the largest (and typically most efficient) firms do the most direct exporting, while midsize and small firms that export rely on intermediaries.

Intermediaries may play an equally significant role for exporters in another way. “You might think that when a firm uses an intermediary to break into the Turkish market, it starts to learn about the market on its own, and it initiates direct contact with Turkish buyers,” Khandelwal says. “Then the firm may not need rely on intermediaries in the future.” The researchers do find support for this idea that intermediaries also play a role in helping exporters get a direct export line into new markets, facilitating future direct trade: firms that used an intermediary in a previous year were much more likely to export on their own in subsequent years.

With so much riding on a nation’s ability to compete internationally on trade, the question of how exports get to market — and in particular, why more firms don’t engage in direct exporting — is a salient one. One way both recent presidential administrations have approached expanding exports is by subsidizing firms the government deemed likely to produce successful exports. But it’s not obvious, says Khandelwal, that intermediaries couldn’t do this better. “Because intermediaries connect buyers and sellers, they have very good information from both sides of the market. As a result, they can convey sudden swings in the market environment to their clients.”

With intermediaries playing so central a role transferring information between and connecting buyers and sellers, they may be ideal export facilitators. “There may be a lot of ways to export products — through direct government transfer or intermediaries or direct exports,” says Khandelwal. “The latter two are the role of the private sector; when it comes to exporting, it might be enough to let the government create a strong climate for business, and then let the private sector work.”

Amit Khandelwal is associate professor of finance and economics and a senior scholar the Chazen Institute of International Business at Columbia Business School.

Shang-Jin Wei is NT Wang Professor of Chinese Business and Economy in the Finance and Economics Division and the director of the Chazen Institute of International Business at Columbia Business School.

Amit Khandelwal

Professor Khandelwal teaches an elective course on International Business. His research research interests examine issues in international and development economics, including the strategic response of firms to trade liberalizations and increased international competition.

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Shang-Jin Wei

Shang-Jin Wei has been Professor of Finance and Economics and N.T. Wang Chair in Chinese Business and Economy at Columbia University's Graduate School of Business since 2007. He is also Director for the National Bureau of Economic Research's Working Group on the Chinese Economy and a Research Fellow at the Center for Economic Policy Research (Europe). Before joining Columbia University, he had had the positions...

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JaeBin Ahn, Amit Khandelwal, Shang-Jin Wei

"The Role of Intermediaries in Facilitating Trade"


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