**Policy, Re"uch, and External Affairs**

# **Trade Policy**

WPS **594** This paper -- a product of the Trade Policy Division, Country Economics Departmentis part of a larger cffort in PRE to study industrial competition, productive efficiency, and theii relation to trade regimes. Copies are available free from the World Bank, 1818 H Street NW, Washington DC 20433. Please contact Sheila Fallon, room N10-035, extension 37947 (39 Pages).

is part of a larger Common wisdom dictates that increased exposure to global markets increases the elasticity of demand perceived by domestic producers, which in tum shifts production toward larger, more efficient plants. Rationalization of production is more pronounced when there are few barriers to entry and exit of firms, because inefficiently small plants are induced to shut down.

Simulation models support the perceived wisdom that liberalization of imperfectly competitive industries in developing countries results in larger plants and more efficiency. But there is little microeconometric evidence to confirm the adjustment mechaniisms these models assume.

To see if these effects could be confirmed, Roberts and Tybout examined annual plant data from Chile and Colombia, using a simple model that summarizes some effects of trade exposure on producer size and productive efficiency. They found thal: Increased exposure to import competition appears to clearly _reduce_ the size of all plants in both the short run and (especially) the long run. The popular belief that trade liberalization will increase average plant size in import-compeling sectors is not supported by recent Chlilean and Colombian experience. This may mean that liberalization does not necessarily improve productivity, but their flndings are not strong enough to warrant strong conclusions.

* The results depend greatly on whether barriers to finns' entry and exit are high or low. The effects of changing output levels, import and export shares, and effective protection rates are systematically moderated by the possibility of easy entry or exit. It could be that output adjustment by incumbent plants has less of a role when the number of plants adjusts to shifts in demand. Or it could mean that high tumover reflects competitive pressure and reduces the marginal impact of foreign competition on market structure.

* Long-run and short-run correlations of trade regimes and distribution of plant size are quite different. Slhort-run correlations associate exports with relatively large plants; long-run correlations associate exports with relatively small plants. Roberts and Tybout suggest caution in basing policy decisions on either finding.

These findings cast doubt on the mechanisms linking trade, planl size, and productivity in recent analytical and simulation studies.

F **The** PRE Working Paper Series disseminates **Lhe** findings of work under way **in the** Bank's Policy, Research, and **Extemal**<sup>**7**</sup> Affairs Complex. Anobjective of the series is to get these findings out quickly, even ifpresentations are less than fully polished. The findings. interprctations, and conclusions in these papers do not necessarily **reprcSCnt** official Bank policy.

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