International Trade and Industrial Evolution: An Empirical Framework for Policy Analysis

Industrial sectors are continually evolving in terms of the variety of products they offer, the mix

of their active producers, the prices these producers charge, and their productive efficiency. Using

plant-level panel data from developing countries, this project characterizes the way that these

evolutionary processes respond to trade policy reforms and to changes in the exchange rate

regime. The analysis is based on structural models of industrial evolution that highlight producer

heterogeneity, firm-specific productivity shocks, new firms' start-up costs, and uncertainty about

the future. By moving away from representative plant analysis, the project captures many micro

features of industrial sector responses that the existing trade literature misses.

The basic model used in this project quantifies an industry's dynamic response to changes in the

intensity of import competition. It characterizes the time paths of firm-level capital gains and

losses, entry and exit patterns, price-cost mark-ups, job creation and destruction, average

productivity, productivity dispersion, and the menu of product varieties available to consumers.

Generalizations of the basic model are also analyzed. These allow firms to export some of their

output when it is profitable for them to do so, and/or to make investments that expand their

capacity or imperfectly control their productivity shocks. The generalized models address

additional issues, including the question of how import competition or exporting opportunities

might induce or discourage investment and productivity growth. All versions of the model

quantify the role of expectations and policy credibility in shaping responses to policy reforms.

The models are econometrically fit to large data sets that the principal investigators have acquired

from Colombia, Morocco, and Taiwan. For each country, these multi-year data sets contain

detailed plant- or firm-level information on sales revenues and input costs. Augmented by data on

tariffs, the exchange rate, and the total value of imports, this cost and revenue information

supports estimation of the basic model. For the extended models, data on export revenues and on

productivity-enhancing expenditures (like fixed investment, worker training and technician

salaries) are also used.

The methodological contribution of the project is to adapt applied industrial evolution models to

an open economy setting, and to implement these models using available micro data. In so doing

the project breaks new ground concerning the measurement of sunk start-up costs and firm-specific

productivity trajectories. The project also facilitates policy debates by quantifying many

dimensions of industrial responses to policy reforms in a single integrated framework. The

consequences of commercial policy reforms that are of interest to business and labor (changes in

profitability, capital gains or losses, and job creation or job destruction) are measured and

compared to the consequences of interest to consumers (changes in prices and the available menu

of product varieties).