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4.2 Trade Liberalization and Within-Firm Changes
66 b oostin G Pro D u C tivity in s ub- sA h A r A n Afri CA
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. Productivityenhancing 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 African countries: Burundi, Cameroon,
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Côte d’Ivoire, Ethiopia, Ghana, Kenya, Tanzania, Zambia, and Zimbabwe (Van Biesebroeck 2005). Postexport productivity growth (learning by exporting) for these firms is attributed to the reduction of credit and contract enforcement constraints. However, evidence of postexport growth is not robust. The finding of a positive correlation between exports and firm productivity in Ghana, Kenya, and Tanzania suggests that (a) highly productive firms are more likely to enter export markets, and (b) learning by exporting is not fully supported by the data.
Finally, the destination of exports also matters to productivity among firms engaged in international trade. Firms exporting to other African countries tend to exhibit lower productivity than firms exporting to the rest of the world (Bresnahan et al. 2016; Mengistae and Teal 1998).
least to the most profitable firms can still improve industry-level performance. This section reviews the evidence of trade policy’s impact on misallocation in select African countries.
Trade reforms can contribute to the reallocation of factors of production from the least-productive to the most-productive firms, thus boosting the industry’s performance and that of the overall economy. From an individual producer perspective, these reforms are exogenous and can affect the market shares of a particular industry. Changes in market shares toward more-productive firms have the potential to raise aggregate productivity (Collard-Wexler and De Loecker 2015). The reallocation process plays an important role in improving performance, and its impact depends on the initial dispersion of productivity—that is, the dispersion before the reform (Pavcnik 2002).
Tariff policies. Tariff policies have led to distortions in the allocation of resources across manufacturing firms in Sub-Saharan African countries. Changes in output and input tariffs create wedges that lead to a dispersion in marginal revenue products across firms. Output tariffs distort competition, while input tariffs create distortions in capital and other intermediate inputs markets. Alleviating or eliminating these distortions through trade reforms is conducive to a more efficient allocation of factors across firms (De Loecker and Goldberg 2014).
Preferential incentives. Trade policies that support prioritized subsectors and regions may also distort the allocation of factors and hence lower aggregate productivity. In Ethiopia, import substitution policies provided a series of incentives to firms in priority sectors from 1996 to 2002—for example, subsidies such as tax exemptions and loss carry-forwards as well as easier access to credit. These policies led to the entry or survival of inefficient firms, and the later removal of these policies facilitated the exit of the less-productive firms and incentivized firms to grow at a faster pace.
Such policies were followed by export promotion policies from 2003 to 2012, complemented by the 2002 investment proclamation that removed the classification of subsectors as “pioneer” and “promoted.”11 The export promotion policies granted incentives based on the export capability of agroindustry and manufacturing firms (Gebresilasse 2016). The export-based eligibility criteria of the 2003–12 policies could reduce the misallocation of resources by compelling firms to be efficient—because exposure to foreign competition requires a high level of efficiency.
Firms in sectors that had been targeted during the import substitution period (1996–2002) tended to have lower marginal products and lower TFPR than nontargeted firms. Ethiopian firms eligible for these pioneer and promoted sector benefits also exhibited lower physical productivity (TFPQ).
