Citation:

Abstract:

We build a dynamic model of …rm-level adjustment to trade liberalization that jointly in-
corporates the main salient features highlighted by recent empirical micro-level studies of …rms
and trade. Our model captures the joint entry, exit, export, and innovation decisions (subject
to sunk costs) of heterogeneous …rms as they adjust to trade liberalization. We characterize
this industrial evolution over its entire transition path to a new steady state with lower trade
costs - starting from the time that trade liberalization is …rst announced (but not necessarily yet
implemented). We rely on numerical methods to solve for these equilibrium paths. In order to
more accurately capture the dynamics of …rm adjustments to trade, we model the sunk nature
of market entry costs for both the domestic and export market - as well as the per-unit and
additional …xed costs of exporting incurred in every period. Firm-level productivity evolves
stochastically, and innovation involves a trade-o¤ between its cost and a return in terms of a
“better”distribution of future productivity draws.
Although the empirical micro-level studies of …rms and export status initially emphasized
the selection e¤ects of more productive …rms into export markets, several recent studies have
highlighted a separate channel for the e¤ects of trade on productivity operating through …rm-
level improvements in productivity. Our model captures both of these channels for the pro-
ductivity enhancing e¤ects of trade - and analyzes their interactions over the adjustment path
to lower trade costs. In particular, we highlight how the relative timing and magnitude of
…rm-level productivity improvements and export market entry decisions are also determined
by non-technological factors such as the timing of trade liberalization announcements and the
speed of liberalization. Under all these di¤erent trade liberalization scenarios (anticipated ver-
sus surprise, gradual versus sudden), we characterize both the distributional e¤ects across …rms
as well as their aggregate e¤ects for industrial performance. We …nd that the anticipation of
upcoming liberalization, and a more gradual path of liberalization (once implemented) induces
…rms to innovate ahead of export market entry.