a lot of attention, is the effect of trade liberalization on indigenous producers in import-competing sectors and indigenous producers relying on imported inputs. In both cases, trade liberalization has been found to have a positive effect. For instance, Pavcnik (2002), who considers the Chilean trade liberalization, shows that plants in import-competing sectors grew by 3 to 10 percent more than those in sectors which were not exposed to foreign competition. Her findings suggest that Chilean plants had to improve their performance in response to exposure to competition from abroad. Fernandes (2006) demonstrates similar improvements in Colombia, as do Krishna and Mitra in India (1998), Muendler (2004) in Brazil and Goh and Javorcik (2006) in Poland. Analyzing the effects of trade liberalization in upstream manufacturing sectors, Amiti and Konings (2005) find a strong positive relationship between trade liberalization in intermediate inputs and firm productivity in downstream manufacturing sectors. Muendler (2004), however, concludes that this channel plays only a minor role.

The second channel, which has also been extensively investigated, is the impact of foreign direct investment on indigenous firms. A large number of studies consider the effect of foreign entry on indigenous producers operating in the same sector, postulating that foreign entry may result in knowledge spillovers to local firms (which would have a positive effect on the performance of the latter) as well as in local producers losing part of their market share to foreign entrants (which would have a negative effect as local producers would have to spread their fixed cost over a smaller scale of production). Empirical analyses based on firm-level panel data produce mixed results. Aitken and Harrison (1999), Djankov and Hoekman (2000), Konings (2001) and Javorcik (2004) find that the overall effect of these two forces is either negative or statistically insignificant, while Haskel, Pereira and Slaughter (2002) and Keller and Yeaple (2003) find a positive effect. More recently researchers have also analyzed inter-industry effects of foreign entry. Javorcik (2004) finds a positive effect of FDI on local producers in upstream industries and no significant effect on local producers in downstream manufacturing sectors in Lithuania. Kugler (2006) documents a positive effect of FDI inflows on Colombian producers in other sectors, i.e. sectors other than the sector receiving FDI. He considers the pairwise effects between sectors without distinguishing between the effects on downstream versus upstream sectors.

While the focus of this paper is on the relationship between services liberalization and the performance of domestic firms in downstream manufacturing sectors, we will also examine the impact of trade liberalization and foreign presence in both own and upstream manufacturing sectors. First, however, we turn to the developments in services sectors in the Czech Republic.

# **3 Services Liberalization in the Czech Republic**

# **_3.1 Services Reform_**

Having made substantial progress in liberalizing services sectors and opening its economy to foreign direct investment, the Czech Republic is a suitable choice for our study. Within a few years after the end of the communist regime in 1989, the government of the former Czechoslovakia privatized many state-owned enterprises, liberalized prices and wage-setting and began to open the country to foreign trade and FDI (Hanousek, Kocenda and Lizal 2004). In 1998, Czech policy makers adopted an even more welcoming approach to foreign direct investment, particularly in services industries, and FDI inflows saw a steep rise. A summary of the reform measures undertaken in the banking, telecommunications and energy sectors is presented here, while Appendix A contains a more detailed description.

In the telecommunications sector, the monopoly fixed line operator was majority public-owned in 1998, and there was no independent regulator for the sector. In early 2000, the Telecommunications Act established an independent regulator and determined that the fixed line monopoly of the incumbent would end on January 1, 2001. Yet, as interconnection prices remained above comparable prices in the European Union and certain other reform-related issues had not been addressed, the EU called for immediate remedial action. A third mobile operator entered the market in 2000 with 100% foreign ownership, and in 2001 the foreign private investor in one of the two mobile companies operating since 1996 increased its shares to 60%. In August 2002, the government decided to privatize the state’s majority stake in the incumbent fixed line operator. Now there is a choice of operators in all segments of the market, and 5