# **_1. Introduction_**

Opening to trade can boost productivity growth through numerous channels. The literature identifies two main groups of mechanisms through which trade can affect productivity: i) those that induce changes _within firms_ and hence impact firm level productivity; and ii) mechanisms that trigger _intra-industry reallocation_ of resources towards more productive firms, thereby increasing aggregate productivity. Improvements in firm level productivity caused by within firm changes can be triggered by exposure to competition stemming from output tariff reduction (the so-called import competition channel) and are associated with (observable) actions, for example, as investment in new technologies, increase in R&D, and entry in export markets.<sup>2</sup> Within firm improvements in productivity can be also triggered by reduction of input tariffs - which allows firms to access better quality, higher variety and lower priced inputs (the so-called input channel) - or by reallocation of firm product mix towards more profitable products.<sup>3</sup> Trade liberalization can affect aggregate productivity as well, as trade shocks are expected to reshuffle market shares towards more efficient firms,<sup>4</sup> in this case, the magnitude of this reallocation process depends on how dispersed productivity was prior to trade liberalization shocks.

Empirical evidence for Brazil has shown that the unilateral trade liberalization episode of the late 1980s - early 1990s has brought positive payoffs to productivity. Using sector level data for the 1985/97 period, Rossi Jr and Cavalcanti Ferreira (1999) show that a 10 percent reduction of import tariffs is associated with an increase in labor productivity growth of 0.88 percent per year and of TFP growth by 3.3 percent per year at the sectoral level. Muendler (2004) uses firm level data for the manufacturing industry in the 1986-1998 period to analyze how the reduction of inward trade barriers between 1990 and 1993 affected productivity and finds evidence that foreign competition pressures firms to raise productivity markedly, whereas the use of foreign inputs plays a minor role for productivity change. Schor (2004) runs a firm level analysis also for manufacturing industry and for the same period and finds evidence that along with higher competition pressure exerted by output tariff reduction, new access to better inputs also contributes to enhance productivity after trade liberalization. Lisboa, Menezes Filho and Schor (2010) use 1988-1998 data and confirm that the trade liberalization episode that took place in Brazil in the late 1980s and early 1990s brought positive impacts for productivity in the manufacturing industry and that the main driver of productivity growth was the reduction of input tariffs.

Productivity dividends accruing from trade liberalization can be maximized when domestic markets are integrated in a way that resources are allocated to their most efficient uses. Easing barriers to trade is expected to trigger an intensive reallocation and churning process where resources are expected to move to more productive uses, within and between firms, sectors and regions, therefore boosting productivity growth. In this context, resource reallocation can be dampened by policy interventions. For example, Restuccia and Rogerson (2017) provide a

> 2 See for instance Bustos (2011) and Aw, Roberts and Xu (2011) as examples of studies covering this type of effect. 3 See Fernandes (2007), Topalova and Khandelwal (2011), and Halpern, Koren and Szeidl (2015) as examples of studies assessing the relevance of the input channel, while Bernard, Redding and Schott (2010) provide empirical evidence for the within-firm reallocation process.

> 4 See Melitz (2003) and Melitz and Ottaviano (2008) for a theoretical and empirical investigation on this aspect, and Pavcnik (2002) for empirical evidence on the productivity dividends coming from the reallocation effects caused by trade liberalization in Chile.

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