This paper describes the extent of product creation and destruction in a large sector of the US economy. We find four times more entry and exit in product markets than is found in labor markets because most product turnover happens within firms. Net product creation is strongly procyclical and primarily driven by creation rather than destruction. We find that a cost-of-living index that takes product turnover into account is 0.8 percentage points per year lower than a “fixed goods” price index like the CPI. The procyclicality of the bias implies that business cycles are more volatile than indicated by official statistics. (JEL E31, E32, L11, O31)

Economists since John Richard Hicks have known that one of the principal means, if not the principal means, through which countries benefit from international trade is by the expansion of varieties. The seminal work of Paul R. Krugman (1979) brought the study of varieties into sharp focus by presenting a simple generalequilibrium model in which countries gain from trade through the import of new varieties. Since then, economists have been hampered in their ability to quantify the impact of new varieties on national welfare by the econometric and data hurdles that need to be surmounted. In this paper, we document some stylized facts about the growth in global varieties which suggest that there may have been substantial welfare gains through the import of new varieties. Moreover, we calculate the impact of increased variety on import prices and find that conventional measures of import price inflation may be dramatically biased upward. Classical international-trade theory postulates that the elimination of trade barriers improves welfare by reducing the wedge between domestic and import prices as well as the ensuing deadweight loss. An entirely different reason for the gains from trade arises from models of monopolistic competition. If consumers value variety and countries cannot produce all varieties due to a fixed cost in the production of each variety, countries stand to gain from trade because it expands the set of available varieties. In these models, the gains hinge crucially on a number of parameters and variables. The first is the elasticity of substitution among varieties. If varieties are highly substitutable, as might be true for varieties of gasoline, then increasing the number of varieties is unlikely to have much of an effect on prices and welfare. Second, quality variation across varieties may matter. Presumably, most Americans care more about having access to French red wine than to Japanese red wine. Finally, import quantities matter as, ceteris paribus, one cares more about variety growth in big sectors than in small sectors. In Broda and Weinstein (2004), we carefully estimate the impact of increased variety in the United States over the period from 1972 to 2001. Using the most disaggregated import data available, we document that the number of varieties imported by the United States, defined as the number of import categories multiplied by the average number of source countries for each category, quadrupled. About half of this increase was due to increases in the number of categories and half due to a doubling of the number of countries from which the United States imported each good. Measuring the impact of this increase on U.S. import prices and welfare is a complex process that we will only discuss briefly here. Essentially, we used Robert C. Feenstra’s (1994) methodology to estimate 30,000 elasticities and then construct an aggregate price index that is robust to common changes in quality variation, the arbitrary splitting of categories, the introduction of new goods, and a host of other data problems. After reconstructing the U.S. import price index, we found that the price of U.S. imports has been falling at a rate 1.2 percent per year faster than one would have thought without taking new varieties into account. To get some sense of the enormity of this bias, consider that the impact of quality adjustments on the consumer price index is estimated to be 0.6 percent per year. Using this adjusted import price index, we estimate the impact of new imported varieties on * Broda: Research Department, Federal Reserve Bank of New York, 33 Liberty Street, New York, NY 10045; Weinstein: Economics Department, Columbia University, 420 W. 118th Street, New York, NY 10027, and NBER. We thank Joshua Greenfield for excellent research assistance. We thank Robert Feenstra and Peter Klenow for excellent comments. 1 “The extension of trade does not primarily imply more goods ... the variety of goods available is (also) increased, with all the widening of life that that entails. There can be little doubt that the main advantage that will accrue to those with whom our merchants are trading is a gain of precisely this kind ... . This is a gain which ‘quantitative economic history,’ which works with index numbers of real income, is ill-fitted to measure, or even to describe” (Hicks, 1969 p. 56).

We show that supply-side financial shocks have a large impact on firms’ investment. We develop a new methodology to separate firm borrowing shocks from bank supply shocks using a vast sample of matched bank-firm lending data. We decompose aggregate loan movements in Japan for the period 1990–2010 into bank, firm, industry, and common shocks. The high degree of financial institution concentration means that individual banks are large relative to the size of the economy, which creates a role for granular shocks as in Gabaix’s (2011) study. We show that idiosyncratic granular bank supply shocks explain 30–40 percent of aggregate loan and investment fluctuations.

We find that prior to World Trade Organization membership, countries set import tariffs 9 percentage points higher on inelastically supplied imports relative to those supplied elastically. The magnitude of this effect is similar to the size of average tariffs in these countries, and market power explains more of the tariff variation than a commonly used political economy variable. Moreover, US trade restrictions not covered by the WTO are significantly higher on goods where the United States has more market power. We find strong evidence that these importers have market power and use it in setting noncooperative trade policy. (JEL F12, F13)

This paper explores the usage of various industrial policy tools in Japan. Contrary to the conventional wisdom, the authors find that a disproportionate amount of Japanese targeting occurred in low-growth sectors and sectors with decreasing returns to scale. In addition, they find no evidence that productivity was enhanced as a result of industrial policy measures. Copyright 1996 by MIT Press.

We develop an approach to measuring the cost of living for CES preferences that treats demand shocks as taste shocks that are equivalent to price shocks. In the presence of relative taste shocks, the Sato-Vartia price index is upward biased because an increase in the relative consumer taste for a variety lowers its taste-adjusted price and raises its expenditure share. By failing to allow for this association, the Sato-Vartia index underweights drops in taste-adjusted prices and overweights increases in taste-adjusted prices, leading to what we call a “taste-shock bias.” We show that this bias generalizes to other invertible demand systems.

ABSTRACT We examine the effects of bank–firm relationships on firm performance in Japan. When access to capital markets is limited, close bank–firm ties increase the availability of capital to borrowing firms, but do not lead to higher profitability or growth. The cost of capital of firms with close bank ties is higher than that of their peers. This indicates that most of the benefits from these relationships are appropriated by the banks. Finally, the slow growth rates of bank clients suggest that banks discourage firms from investing in risky, profitable projects. However, liberalization of financial markets reduces the banks' market power.

This paper examines the impact of retail e-commerce on pricing behavior and welfare. Using Japanese data, we find that e-commerce lowered relative inflation rates for goods sold intensively online. We use long time series and historical catalog sales as an instrument for e-commerce sales intensity. The entry of e-commerce firms raised the rate of intercity price convergence in physical stores for goods sold intensively online, but not for other goods, which suggests e-commerce enhances price arbitrage. We estimate that e-commerce lowered variety-adjusted prices on average by 0.9% between 1996 and 2014, and more in cities with highly educated populations.

Bilateral trade deficits are a perennial policy issue. Former Deputy Assistant U.S. Trade Representative for Japan and China, Merit Janow (1994 p. 55), notes that during the first George Bush administration, “High deficits coupled with the continuing allegations from U.S. business interests about the closed nature of the Japanese market were resulting in serious domestic political pressures for improved access to the Japanese market.” Recently Robert C. Feenstra et al. (1998 p. 1) made similar comments vis-a-vis China: “Some analysts have interpreted the large U.S.–China bilateral trade deficit as prima facie evidence of unacceptably high levels of protectionism in China, and have advocated stringent entry conditions for China’s admission into WTO.” Given the policy salience of bilateral trade deficits, it is peculiar that no one has ever examined them empirically for a broad set of countries. One reason for the scant study is that economists are naturally (and sensibly) loath to accept the terms of the policy debate, which considers bilateral trade deficits ipso facto harmful. A second reason is that economists believe there may be very natural explanations for bilateral imbalances. One such explanation finds its origins in macroeconomic identities that equate current-account deficits to an excess of investment over saving. From this, it may be argued that bilateral imbalances will arise naturally in trade between countries in aggregate surplus and those in aggregate deficit. Indeed, this is the principal explanation that the profession has given policymakers, and it forms the foundation of many U.S. bilateral trade initiatives such as the Structural Impediments Initiative and the Framework talks. Janow (1994 p. 55) observes that “there was (and is) little disagreement among economists that the causes of large aggregate and bilateral deficits are largely attributable to macroeconomic factors” [italics added]. A second account may rely on what may be termed “triangular trade,” in which cross-country differences in the patterns of demand and supply mean that a country will run bilateral deficits with those countries that are unusually important suppliers of the goods for which the deficit country happens to be an unusually strong demander. In this paper, we use the canonical “gravity model” of bilateral trade to form predictions about bilateral trade balances. We develop two key variants of the model, in which bilateral trade imbalances arise due to aggregate macroeconomic imbalances or due to “triangular trade,” and we implement these empirically for a broad set of countries. Our results paint a dismal picture. The central explanations that economists provide to explain bilateral balances perform miserably. There are two key failures. First, actual bilateral trade imbalances are much larger than those predicted; there is a “mystery of excess trade balances.” Second, even after we allow for both macroeconomic imbalances and idiosyncrasies in the structure and levels of demand and production, the models perform poorly in explaining bilateral trade balances. These failures of economists’ standard explanations of bilateral trade imbalances require that we move beyond the simple gravity framework to consider alternative explanations: homogeneous goods, highly specialized intermediates, and the role of policy.

A half century of empirical work attempting to predict the factor content of trade in goods has failed to bring theory and data into congruence. Our study shows how the Heckscher-Ohlin-Vanek theory, when modified to permit technical differences, a breakdown in factor price equalization, the existence of nontraded goods, and costs of trade, is consistent with data from ten OECD countries and a rest-of-world aggregate. (JEL F1, F11, D5)