# **1 Introduction**

In the past few decades, countries across the world have lifted barriers to trade. More firms are now selling their products to global markets while also purchasing inputs from across the world. In India, the number of manufacturing firms reporting positive exports rose from less than 600 in 1989 to about 2 _,_ 500 in 2005.<sup>1</sup> At the same time, there have been vast differences in productivity documented across firms. Firms in the 90th percentile have been found to be almost twice as productive as firms in the 10th percentile in several countries including India, China and the United States.<sup>2</sup> Given the increasing global nature of production, there is a need to understand the role of trade in explaining these vast differences in productivity across firms. This is also important from a policy point of view. If firms improve productivity through exports, there may be a case for export promotion policies by governments to lower entry costs into export markets and encourage exports.

Theoretical models of trade argue that the relationship between exports and productivity should be potentially bidirectional, i.e., more productive firms will begin to export and becoming an exporter makes a firm more productive. Melitz (2003) models self-selection of more productive firms into export markets due to a fixed cost of entry into export markets, while Bustos (2011), Lileeva and Trefler (2010) and Melitz and Costantini (2007) emphasize export-technology complementarity, where access to larger markets through entry into export markets allows firms to invest in innovative activities and thus improve productivity. Empirical studies have documented a positive correlation between productivity and export participation. While there is substantial evidence that the more productive firms self-select into exporting, the evidence on whether firms improve productivity post entry into export markets is not so clear-cut. Several empirical papers have confirmed that more productive firms self select into export markets. For example, see Delgado et al. (2002) and Bernard and Jensen (1999). Girma et al. (2004) review 10 papers and find widespread evidence of the self selection hypothesis. Clerides et al. (1998), Arnold and Hussinger (2005) and Greenaway et al. (2005) find that exporting does not improve productivity. This also holds for evidence from 14 countries presented in ISGEP (2008). Notable exceptions which have found evidence of improvements in productivity post entry into export markets include De Loecker (2007) and Biesebroeck (2005). Previous work on India confirms the self-selection hypothesis but does not find evidence that exporting improves firm productivity (see Haidar (2012) and Sharma and Mishra (2011)).

One possible explanation for the lack of evidence (on firms becoming more productive after they begin exporting) found in the data could be that previous studies have usually estimated revenue productivity (i.e., the measure of output used in the production function uses industry level prices to deflate firm revenues rather than firm level prices). These studies assume common prices for all firms within an industry. If firms improve productivity and pass this on to consumers

> 1These numbers are based on public firms, which are legally required to report foreign exchange transactions.

> 2See Syverson (2004) for the United States and Hsieh and Klenow (2009) for China and India

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