Network Intermediation in International Trade: Theory and Evidence

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The principal investigator's prior NSF-supported research has used disaggregated trade data to identify and quantify the need for travel and the usefulness of business and social networks in overcoming informational barriers to international trade. The PI has also developed theoretical models of the consequences of the existence of informational barriers for the functioning of the world economy. This research has raised (at least) three questions. First, can more direct, microeconomic evidence be found for the relatively greater importance of foreign travel, and of private than publicly available information, in the search for foreign buyers or sellers of differentiated than homogeneous products? Second, can any direct evidence be found on if and how new information technology is affecting the search for foreign buyers or sellers? Third, and most important, does the apparent importance of informational barriers to trade and the usefulness of transnational networks in overcoming them have any implications for policy? A survey of intermediaries such as export management companies, export trading companies, importers, and buying agents, guided by a theory of "network intermediation," could help to answer all these questions. The PI will develop such a theory and perform a pilot survey that will determine the feasibility of a full-scale survey. More specifically, the trade-creating impacts of immigrants, foreign direct investment by business groups, and long-settled ethnic minorities that maintain co-ethnic business societies (such as the Overseas Chinese) found by various researchers suggest that existing intermediaries are inadequate means of connecting buyers or sellers to foreign opportunities. The apparent importance of belonging to these transnational business and social networks does not prove that intermediation is undersupplied, however, because the costs of establishing each of these transnational networks were sunk for purposes other than creating trade. It could be that the costs of setting up new intermediaries would outweigh the benefits of the additional trade they would create. A preliminary theoretical model suggests that market failure may indeed exist in provision of "network intermediation." Network intermediaries are agents who, in effect, sell access to their networks, which consist of firms of whose capabilities and preferences they have the "deep knowledge" necessary to match them to appropriate buyers or sellers of differentiated products. It is hypothesized that such agents accumulated their deep knowledge of the firms in their networks by having worked with them in a non-intermediary capacity before entering careers as intermediaries when this became more profitable. This process is unlikely to supply intermediaries whose networks span many product lines, however, which are valuable if for example clients want to buy many components that need to be matched to each other. Moreover, investment in network diversification may fall short of the socially optimal level because the deep knowledge intermediaries need of the members of their networks in order to find the best matches for their clients. The quality of their service is inherently non-contractible, leaving them vulnerable to the hold-up problem given the specificity of each match. One of the policy recommendations of the model (established in a general equilibrium framework with endogenous supply of intermediation) is thus a subsidy to large, diversified intermediaries in particular. Indeed a number of countries (including the United States) have adopted policies to encourage the establishment of such intermediaries. The pilot survey will be designed to test a number of hypotheses drawn from this model.