Technology Adoption and the Selection Effect of Trade,” Working

Recent productivity studies suggest the reallocation of output across plants (between effect) and the productivity growth at individual plants (within effect) are both important sources of productivity growth at the industry level. Interestingly, recent evidence has shown that trade liberalization is related to both effects. While a trade model with firm heterogeneity can explain the between effect, it can not reproduce the within effect. We add to this model the option for firms to costly adopt more productive technologies and show that plant productivity actually rises in response to lower trade costs. The selection effect of trade- that some firms will be forced to exit following trade liberalization- favours the reallocation of output across incumbent firms (between effect) and contributes to raise the exporters ’ market share. Therefore, a greater scale of operation amplifies the firm’s return from costly productivity-enhancement investments and leads a greater proportion of firms to undertake process-innovations (within effect)