The Origins of Firm Heterogeneity: A Production Network Approach

This paper quantifies the origins of firm size heterogeneity when firms are interconnected in a production network. Using the universe of buyer-supplier relationships in Belgium, the paper develops a set of stylized facts that motivate a model in which firms buy inputs from upstream suppliers and sell to downstream buyers and final demand. Larger firm size can come from high production capability, more or better buyers and suppliers, and/or better matches between buyers and suppliers. Downstream factors explain the majority of firm size heterogeneity. Nearly all the downstream variation is driven by network sales to many buyers rather than to final demand. Conversely, nearly all the upstream variation is driven by own production capability rather than input purchases from the network. Models that feature only supply-side factors such as firm productivity or that ignore the input-output structure of the economy would fail to capture the vast majority of firm size heterogeneity. Counterfactual analysis suggest that the production network accounts for more than half of firm size dispersion.