Trade Liberalization and Firm Productivity: Evidence from Chinese manufacturing industries ∗

We examine the impact of tariff reduction following China’s WTO entry on the productivity of Chinese manufacturing firms using a firm-level panel database that comprises all of China’s manufacturing firms with an annual turnover above five million yuan and that spans the period of 2000 to 2006. We use an instrumental variable estimator to account for the endogeneity of the tariff reductions. Our results indicate that China’s trade liberalization in the five years following its WTO entry has led to a 0.94 percent annual increase in total factor productivity for Chinese manufacturing firms. However, the overall productivity gain from the tariff reduc-tions is a net result of a productivity depressing effect of output tariff reduction and a productivity enhancing effect of input tariff reduction. Both effects have di-minished in magnitude over the years after China joined WTO. Firm heterogeneity and turnover plays an important role in generating gains from trade liberalization. The surviving firms have managed to cope with and take advantage of lower tariffs. The extent to which the tariff reduction affects Chinese firms ’ productivity is also dependent on the ownership structure of the firms with foreign-invested firms being the clear winner