Monday, July 20th
Shafaat Y. Khan (World Bank) and Armen Khederlarian (Rochester), Inventories, Input Costs and Productivity Gains from Trade Liberalizations
Trade liberalizations and the associated input tariff reductions have been docu- mented to increase firm level productivity. We revisit this result incorporating the fact that sourcing internationally is inventory intensive. After tariff drops, firms switch to lower variable and higher inventory holding costs goods. We show that when firm’s sourcing strategies change, the use of aggregate price deflators sys- tematically leads to mismeasured material input usage. We study the relevance of this potential bias during India’s trade liberalization in the early 1990s. First, we document that inventory holdings of intermediate goods increased significantly in response to input tariffs. Second, we extend a standard productivity estimation procedure with a control function for firm level input costs and re-estimate the productivity gains. We find that the input cost mismeasurement accounts for 20 to 40% of the productivity gains. Consistent with the gradual adjustment to the tariff reductions, the bias in the response of firm level productivity is backloaded.