Heterogeneous Firms, Factor Productivity and Trade

Melitz (2003) showed how trade liberalization induces intra-industry reallocation and enhances average industry productivity through selection effect. In his work, firm productivity playes a major role. However, uncertainty was not taken into account. Our paper will focus on firm productivity under uncertainty. From our view, firm productivity might originate mainly from factor uses and institution. Before market entry, one firm can expect own level of firm productivity by the averaged factor productivity. In addition, institutional difference can generate uncertainty of factor productivity because the factor uses are regulated in the institutions. We think that uncertainty of factor productivity can be an important determinant for the model of firm heterogeneity. Particularly, uncertainty of labor productivity can sharply differ across countries due to some inherited attributes. We will augment the work of Melitz (2003) by incorporating uncertainty of factor productivity and will show that the uncertainty determines the selection effect.