Flexibility And Productivity: Toward The Understanding Of Firm Heterogeneity

We document four new stylized facts using Chinese firm‐level data to show that the standard single‐attribute model of trade, in which firms only differ in productivity, must be augmented with an additional layer of heterogeneity to match the facts. To match the evidence, a model requires heterogeneity in flexibility, namely, the ability to introduce new varieties in a destination at low costs. We calibrate our model and find suggestive evidence of a trade‐off between productivity and flexibility. Furthermore, we show that ignoring firm flexibility causes a large underestimation of the welfare effects of trade.