the same way as the _services_linkage_ variables. Foreign entry into manufacturing industries may affect the sourcing options for manufacturing inputs by increasing the quality and range of products available. To account for the sourcing options offered by imported inputs, _Xjt-1_ also includes the level of tariff protection in upstream manufacturing sectors, again weighted by the input-output coefficients. Our tariff measures are applied MFN tariffs. In preparation for accession to the European Union, Czech tariffs vis-à-vis the EU were governed by a bilateral accession agreement of 1992, which established a schedule for phasing out tariffs on most manufacturing products by the end of 2000. In practice, this means that for the time frame we are investigating, EU preferential tariffs outside the food and tobacco sectors were already very low, with an average tariff of less than half a percent. In the presence of virtual free trade with the EU, it does not seem sensible to exploit the minimal variation in this protection before 2001, and indeed our data show little evidence that this aspect of trade protection matters. Instead we focus on MFN tariffs, which will capture protection vis-à-vis imports from non-EU countries, such as the United States and China. In Appendix G, however, we repeat some of our basic regressions including both EU preferential and MFN tariff rates and show that the results are robust to this change.

Finally, to control for the level of competition and possible knowledge spillovers, we also include measures of foreign entry into a firm’s own sector as well as the level of tariff protection in the same sector.<sup>23</sup> To take into account other factors that may generate a correlation between the performance of manufacturing firms and foreign entry into services sectors, such as regional differences in remoteness or quality of infrastructure, or events that improve business prospects in both services and manufacturing in a specific year, we include firm and year fixed effects. The firm fixed effects will also control for unobserved heterogeneity of firms.

In our second specification, we estimate the model in first differences rather than in levels. Differencing takes out all observable and unobservable time-invariant characteristics at the level of the firm as well as at the level of the industry and region. By including region and year fixed effects in the model in first differences, we additionally control for differences in trends (rather than in levels) that are specific to a particular region or for factors affecting the whole economy in a particular period. For example, differences in regional public spending on infrastructure or economy wide shocks would be picked up by these fixed effects in the differenced equation and would not bias our coefficient estimate of the services linkage variable. Our second specification takes the following form: As the variables of interest are at the industry level while the dependent variable is at the firm-level, we adjust standard errors to allow for correlation between observations belonging to the same industry in the same year. The summary statistics for all variables are presented in Appendix H.

# **5 Results**

The results from the estimation of equation 3 based on OLS productivity estimates are shown in table 2. When we enter the measures of _services_linkages_ into the model one by one, we find a positive and statistically significant correlation between firm performance in downstream manufacturing and the overall liberalization of services (EBRD measure, column I), the presence of foreign providers of services (measured using the two alternative definitions of foreign output in columns II and III) and the extent of privatization in services industries (but only when the capital share definition is used in column V). The effects are statistically significant at the one or at the five percent level. These results support our hypothesis that services liberalization affects the performance of domestic manufacturing firms relying on services inputs. The extent of competition in services, proxied by the concentration ratio (or the Herfindahl index, not reported to save space), does not appear to have a statistically significant effect. When the three aspects of services reform (foreign presence, privatization and competition) enter the model jointly in columns VII and VIII, only the presence of foreign providers is statistically significant. This suggests that

> 23 We have also experimented with concentration measures in the same sector, but these turned out to have no systematic significant effect.

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