Productivity Matters for Trade Policy: Theory and Evidence

Abstract

In the growth literature that investigates the effect of trade liberalization on productivity, nearly all studies assume that trade policy is determined independently of productivity, hence it is exogenous. I show, both theoretically and empirically, that this assumption is not valid in general. I find that in Colombia more productive sectors receive more protection and the sectors with higher productivity gains are liberalized less even in the presence of a large unilateral liberalization shock that affects all sectors. Researchers may be underestimating the positive effect of liberalization on productivity when they do not account for the endogeneity bias.

Keywords: Productivity, trade liberalization, endogeneity, political economy of trade policy, learning-by-doing

JEL Classification: D24, F13, F14