Sizing Up the Impact of Embassies on Exports

DOIhttp://doi.org/10.1111/sjoe.12260
Date01 January 2019
Published date01 January 2019
Scand. J. of Economics 121(1), 278–297, 2019
DOI: 10.1111/sjoe.12260
Sizing Up the Impact of Embassies on
Exports*
Shon Ferguson
Research Institute of Industrial Economics, SE-102 15 Stockholm, Sweden
shon.ferguson@ifn.se
Rikard Forslid
Stockholm University,SE-106 91 Stockholm, Sweden
rf@ne.su.se
Abstract
The purpose of this study is to test for the effects of trade promotion via the foreign service. The
theory of trade with heterogeneous firms predicts that unilateral trade promotion allows medium-
sized firms to export. We investigate the effects of trade promotion using firm-level data and
information on the opening and closing of embassies abroad from the very similar neighboring
countries Sweden and Norway. Weuse a difference-in-difference specification where firms from
Norway are used as a control group for Swedish firms. Our results show that large firms as well
as medium-sized firms respond to the opening of embassies.
Keywords: Heterogeneous firms; trade promotion
JEL classification:D21; D22; F12; F15
I. Introduction
Virtually all countries have foreign representation, for example, in the form
of embassies and consulates. However, as information costs fall in the era
of the Internet, the raison d’ˆetre of foreign representations is in question,
as pointed out by Rose (2007). The response of the foreign services in
many countries is that their activities are important for promoting trade.1
This would be particularly true for Sweden, which is a small open economy
that has not been involved in military conflicts for 200 years.2Given the
large sums spent on maintaining embassies abroad and the popular aim of
governments to promote the exports of small- and medium-sized enterprises
*The authors are very grateful to Esther Ann Bøler for providing and preparing the Norwegian
data for this paper. Financial support from the SwedishResearch Council, the Jan Wallander and
Tom Hedelius Foundation, and the Marianne and Marcus Wallenberg Foundation is gratefully
acknowledged.
1Rose (2007) cites several policy documents asserting this in the US context.
2However, Sweden has contributed troops to United Nations missions.
C
The editors of The Scandinavian Journal of Economics 2017.
S. Ferguson and R. Forslid 279
(SMEs), it is surprising how little we know about how trade promotion via
the foreign service affects different types of firms.
In this paper, we use Swedish and Norwegian firm-level data from 1997–
2006 to measure the effect of embassies on the number of exporters. Trade
promotion can affect both the intensive and extensive margins of trade.
Here, we consider the role of embassies in reducing the fixed market entry
cost to foreign markets, implying that we focus on the extensive margin. A
standard model of trade with heterogeneous firms, such as Melitz (2003),
would predict that lower market entry costs due to trade promotion would
give rise to entry of marginal exporters (firms of intermediate productivity
and size).3Therefore, we disaggregate the industry-level data by firm size
quartiles and we test whether the effect of embassies differs across quartiles
of the firm size distribution.
A serious obstacle when estimating the trade effects of embassies is
that countries might open embassies particularly in countries that have
a high potential for trade. Thus, causality is hard to establish. In order
to improve identification, we use a difference-in-difference specification
with Norwegian exporters as a control group for Swedish firms. The two
neighboring Scandinavian countries, Sweden and Norway, are highly similar
in terms of language, location, development, and industrial structure.4
Therefore, if an emerging market becomes interesting for Swedish exporters
if would likewise be interesting for Norwegian exporters. Therefore, we
use exports from Norwegian firms as a control when Sweden opens up a
new embassy. We test for the effect of trade promotion on the extensive
margin at the four-digit sector level and with firms aggregated to size
quartiles. Our results from the difference-in-difference regressions are that
Swedish embassies are associated with a 4–6 percent increase in the
number of Swedish exporters in the second, third, and fourth quartiles.
Our results are robust to several robustness checks. First, in placebo
regressions, we find that the number of Norwegian exporters did not
respond to the opening and closing of Swedish embassies, which suggests
that the results are not driven spuriously by the economic development
in the destination country. Second, the results are robust to a large
number of alternative specifications including using productivity-based
quartiles.
It is noteworthy that our empirical result – large firms are as affected by
embassies as medium-sized firms – differs from the mentioned theoretical
3For a formal treatment of this, see the workingpaper version of the present paper (Ferguson and
Fors lid,2014).
4The Swedish and Norwegianlanguages are similar enough that Swedes understand Norwegian,
and vice versa. Nationals of the two countries can still todaytravel between the countries without
passports.
C
The editors of The Scandinavian Journal of Economics 2017.

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