Trade costs and international strategy of firms: The role of endogenous product differentiation

We study the impact of trade liberalization on the international strategy of firms (to export and/or invest abroad as well as the number of varieties to be produced) when product differentiation is endogenous. By considering product differentiation as a strategic variable, our analysis sheds new light on the impact of trade barriers on the decision to produce abroad and on the choice of product range, in accordance with recent empirical evidence. We show, even though technology exhibits the same productivity for each variety, firms drop some of varieties with trade integration. In addition, our results reveal that, contrary to the standard theoretical literature, the relationship between the decision to export and trade costs is non-linear. When trade costs are relatively high, firms may export and be multi-product. Finally, the choice of producing abroad results from either a prisoner's dilemma game or a chicken game.

► Multi-product firms choose their product specification in a three-stage location game
► Trade liberalization leads to a decline in the available range of products
► When trade costs are relatively high, firms may export and be multi-product
► The choice of producing abroad results from a prisoner's dilemma game