Trade Openness, Efficiency, and Productivity

A growing number of micro-econometric studies from developing countries show that opening up to international trade improves average industry productivity. Yet, these positive micro-level findings contrast to some extent with the macro evidence. This project addresses this discrepancy in a tractable general equilibrium framework that incorporates credit market imperfections.

We demonstrate how in such a framework an improvement in the average industry productivity can go hand in hand with a fall in the aggregate output. The reason is that opening up to trade may reinforce the (pre-existing) harmful polarisation of the industry structure: with credit markets not functioning well, the trade-related increase in competitive pressure forces less productive firms to cut their output by a large margin. This excessive loss in domestic production has to be replaced by imports from abroad – which is expensive unless the cost associated with trading goods internationally is very low. It turns out that this negative “replacement effect” may be sufficiently strong to balance or even outweigh the positive impact on average industry productivity.

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