Trade liberalization, competition and productivity growth – new evidence from Pakistani manufacturing firms

It is generally believed that a rise in foreign competition makes the industrial sector more efficient. By using a novel firm-level data set from a variety of industries in Pakistan, this paper revisits productivity-liberalization link, and investigates the effect of trade liberalization on competition and firm productivity. We find that productivity gains from reducing overall tariff rates are not obvious from a simple regression of total factor productivity on tariff rates; if there are any gains from reducing tariffs on intermediate goods, they are greatly counterbalanced by reduction in tariffs on final goods. There is evidence of an increase in competition following trade liberalization. In a majority of industries, there is reduction in returns to scale, indicating the existence of inflexible capacity constraints in these industries. Moreover, it offers evidence for the perception that gains from trade liberalization in the form of improvement in firm productivity have been greatly exaggerated.