Trade preferences & heterogenous firms

Contra the Washington Post’s editorial, Svetlana Demidova, Hiau Looi Kee, and Kala Krishna provide additional evidence that trade preferences aren’t obviously beneficial to development in their newest NBER working paper:

This paper models the responses of firms that are heterogenous in productivity to the different types of trade policies they face in different product and export destinations. It presents direct evidence supportive of the model’s predictions using a dataset of Bangladeshi garments exporters. In particular, it focuses on the effect of differences in trade polices, trade preferences, and the rules of origin (ROOs) needed to obtain them, on the pattern of firm exports and performance…

[O]ur work suggests that trade preferences granted to developing countries that favor more capital intensive sectors can distort their pattern of investment and trade. While such preferences tend to spur investment and exports of the more capital intensive sectors, they also reduce the average productivity of exporters and bias export away from the direction of natural comparative advantage. Consequently, even liberal preferences may be far less effective in promoting development than expected…

Thus, the contribution of this paper is as follows. First, our heterogenous firm model shows how differences in trade policy of the EU and US and in the preferences granted by them to Bangladesh, in combination with the ROOs needed to access them, act as a sorting mechanism for firms. This results in productivity differences between firms that differ in their product lines and markets. We are able to capture both how firm productivity differs according to the toughness of the exporting market, and how the toughness of the market depends on ROOs and trade policy. The former channel is missing in homogenous firm models… Finally, in the area of trade policy-for-growth, our paper suggests that liberal preferences given by the EU to Bangladesh, while spurring exports of the non-woven sector, may reduce its average productivity. Given that the non-woven sector is twice as capital intensive as the woven sector, our result further implies that exports of Bangladesh are biased away from the direction of its natural comparative advantage, and as a result, may be less effective in promoting development.

1 thought on “Trade preferences & heterogenous firms

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