66 B o o s t i n g
P r o d u c t i v i t y i n S u b - Sa h a r a n A f r i ca
BOX 4.2 Trade Liberalization and Within-Firm Changes Firms participate in world markets as producers or sellers of goods and as buyers of intermediate inputs used in the production of these goods. Trade policies, therefore, can potentially affect all phases of the firm’s production and expenditure decisions: • Transformation of physical inputs to output • Upgrade (or downgrade) in the quality of the producers’ outputs and inputs • Remuneration of workers of different skills • A firm’s locational choices. The channels through which trade reforms affect firms will depend on the specific nature of the trade policy changes and, particularly, on whether these policy changes affect output relative to input markets. In response to trade shocks, firms are expected to raise their productivity as they undertake actions to become more efficient—say, by adopting better management practices or appointing better managers (Bloom et al. 2013; Schmidt 1997). Productivity improvements are usually linked to investment in new technologies, research and development (R&D), and entry in export markets. Productivity- enhancing actions are associated with inputs; that is, investment will affect not only productivity but also the capital stock (De Loecker 2013). Input Market Costs Exposure to international trade can affect the firm’s performance through changes in the trade cost of inputs. Lower trade costs lead to the import of new intermediate inputs and an increase in production beyond what the increase in expenditures would predict. This increase will be more pronounced if the new inputs are of higher quality than those previously used. If the production technology exhibits a taste for variety, a larger number of imported inputs will translate into higher output (Halpern, Koren, and Szeidl 2015). This mechanism is likely to underlie the large within-firm productivity gains found in studies that examine the effects of input tariff liberalization in India and Indonesia (Amiti and Konings 2007; Topalova and Khandelwal 2011). In fact, input tariff liberalization led to large increases in the number of imported inputs in India (Goldberg et al. 2009, 2010). Firms’ prices and markups will adjust in response to trade shocks. Trade models with monopolistic
competitions and constant elasticity of substitution (CES) preferences render constant markups. Under alternative demand systems, prices and markups tend to respond to trade liberalization (Arkolakis et al. 2019; Feenstra and Weinstein 2017; Mayer, Melitz, and Ottaviano 2014; Melitz and Ottaviano 2008). Multiproduct firms can improve revenue productivity (TFPR) by reallocating within-firm resources from the production of the least to the most profitable products. This mechanism improves firmlevel performance, and it is analogous to the role of reallocation in raising aggregate industry performance. This mechanism only increases TFPR, and this increase is attributed mostly to the reshuffling of resources across products of varying profitability (Bernard, Redding, and Schott 2010). Effects of Tariff Cuts Empirical evidence shows that an industry’s profitability increases with its exposure to foreign competition. Trade liberalization studies focus on episodes of output and input tariff reductions (Amiti and Konings 2007; Pavcnik 2002). The effects of input tariff cuts are larger than those of output tariff reductions in low- and middle-income countries. They typically operate through two channels— within-firm performance and factor reallocation— and the relative importance of each channel depends on the industry’s setting (Melitz and Redding 2014; Melitz and Trefler 2012). The effects of trade liberalization on performance is heterogeneous across firms. Firms with different characteristics—such as initial profit level, R&D expenditure, and capital intensity, among others— tend to cope differently with trade shocks (Aw, Roberts, and Xu 2011; Bustos 2011; Lileeva and Trefler 2010). “Learning by exporting” (the mechanism by which firms’ productivity improves after entering export markets) appears to play an important role when controlling for the fact that entering export markets comes along with higher investment (De Loecker 2013). High-Productivity Export Firms High-productivity firms are more likely to enter international markets and continue raising their productivity—as in the case of export firms in nine A frican countries: Burundi, Cameroon,
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