E Pluribus Unum: Growing TFP from Regional Trade

Abstract

We study how trade shocks shape the distribution and aggregate level of heterogeneous firms’ total factor productivity (TFP). By integrating detailed administrative data and utilizing the Urban Integration Policy (UIP) as a policy shock, we demonstrate that the dismantling of local protectionism and the rise of regional trade in China significantly enhanced firms’ TFP. However, this growth was accompanied by a decline in patenting activity. We argue that the observed TFP growth is predominantly driven by firms engaging in imitation, consistent with a heterogeneous firm trade model that incorporates an imitation-innovation trade-off. Finally, we show that UIP has contributed to over a 10% increase in China’s aggregate productivity, with knowledge diffusion serving as the dominant channel. This finding contributes to the broader understanding of trade’s role in shaping productivity dynamics.

Keywords: total factor productivity, local protectionism, knowledge diffusion, regional trade