The models of Chapter 3, based on technology- and factor endowment differences can explain inter-industry trade but not intra-industry trade – the simultaneous import and export of similar types of goods and services – which is empirically important, especially between rich countries. Competitive pressure by foreign firms and strategic interaction may entice companies to engage in mutual trade flows of homogeneous products, leading to lower mark-ups, lower prices, larger volumes, and welfare gains for consumers. Firms can also engage in trading similar for better use of scale economies, lower prices and access to a larger number of varieties. The international business literature focuses on multinational firms, investigating why some multinationals can do better than others by creating a competitive advantage. In a setting of intra-industry trade, international business (dealing with firm-level competition) thus meets international economics (focusing on country-level trade).

The rising importance of international firms is demonstrated by two main aspects. First, firms are heterogeneous; they differ substantially in the margins of trade and in economic size. The extensive margin indicates if a firm is active in trade flows. The intensive margin indicates the intensity with which firms engage in trading activities. Trading firms tend to be bigger and more productive than non-trading firms. Second, trade flows are dominated by multinational firms operating in two or more countries, including related party trade between firm entities leading to intra-industry trade. Multinationals are concentrated in advanced countries, capital- and R&D intensive, display distance decay in their interactions, are larger and more productive than national firms and have a specific organisational structure. The rise of international firms is related to the changing structure and organisation of trade flows caused by the emergence of global value chains, under the guidance of lead firms.

Productivity diverges widely and persistently between – and most notably within – countries and industries. Connecting the micro and macro perspective is also a challenge productivity research has to face. To tackle such issues, since the early 2010s the Competitiveness Research Network – CompNet – a large European initiative, was created with two main objectives: (i) developing a forum for discussion on productivity research; and (ii) setting up a truly comparable EU dataset of productivity indicators, based on firm-level information of top quality. We will extensively use the research work and the dataset generated by CompNet in this book. Our ultimate objective is to show how we can gather rich and critical information by taking a firm-level perspective, but also argue that despite the progress made, additional EU-wide efforts need to be made on the data front to ensure suffcient depth and accurateness.

Firm heterogeneity is nowadays at the center of trade analysis. There seems to be a link between firms' presence on foreign markets and productivity of individual companies. There is a premium for companies engaging in internationalization activities against those serving only the local market, and these premia seem to increase with the complexity of the internationalization activity. There is causality between firms' innovation and internationalization activities. This implies that innovation policies are a major driver of trade and economic growth. Few firms are able to export, and export is thus very concentrated in a few firms in virtually all countries. This fact means that policymakers might be able to analyse and forecast nearly all aggregate trade figures by predicting a few firms' export value. Responses to exchange rate movements are heterogeneous across firms: export elasticity to REER movements is inversely correlated with size and productivity, and therefore exports by larger and more productive companies are less sensitive to exchange rate movements.

It is necessary to distinguish the productivity of a single production factor from the ability of a firm to combine the bundle of inputs at its disposal to create new value. This is total factor productivity (TFP), also known as multi-factor productivity". Firm performance in a sector or region is not centred around an average performance level. Policies should aim to catalyse the dynamic transition of more-productive firms, rather than just working on the average performance of the sector.