State Dependence and Unobserved Heterogeneity in the Extensive Margin of Trade

Abstract

We study the role and drivers of persistence in the extensive margin of bilateral trade. Motivated by a stylized heterogeneous firms model of international trade with market entry costs, we propose new bias-corrected dynamic binary choice estimators with three sets of high-dimensional fixed effects. Monte Carlo simulations confirm their desirable statistical properties. A reassessment of the most commonly studied determinants of the extensive margin of trade demonstrates that both true state dependence and unobserved heterogeneity contribute strongly to trade persistence and that taking this persistence into account matters significantly in identifying the effects of trade policies on the extensive margin.