Estimating the causal effect of trade protection on productivity in Uruguay Data and methodology issues Carlos Casacuberta Dayna Zaclicever November, 2008

Objective: Discuss some relevant issues in data treatment and estimation strategy Obtain feedback that may help to resolve some challenging alternatives of the project

Data issues –I. Productivity estimation –II. Protection data Methodology –III. Firm level protection, exogeneity and identification strategy

1. Productivity estimation: firm-level quantities and prices Quantities and prices: product sheet contains item, measurement unit, quantity, value. Classification based on ISIC rev.2 + product number + measurement unit code

Quantity indexes: calculate firm-level Törnqvist indexes, where the weights are the product shares of total value of production. Product structures might not be stable. i.e. products may enter or exit the production bundle of the firm. Treatment?

Rest of the sample ( ): we still have the product structure. Instead of deflating by aggregate sector price indexes the firm’s production value, we will use the sector indexes to deflate each product separately to obtain a constant price revenue measure.

2. Protection data: ¿what are the relevant protection variables? Three series: Most favored nation tariff (National tariff); Bilateral preference tariff with Argentina; Bilateral preference tariff with Brazil. Before Mercosur we had MFN tariffs and bilateral preferences set in Agreements Cauce (Argentina) and PEC (Brazil).

Since Mercosur ( ) we had a convergence scheme towards the common external tariff for all members (Argentina, Uruguay, Brazil and Paraguay). Bilateral preferences are allowed. Since 1995 the Common external tariff was supposed to hold and Intrazone tariffs set to 0, but in practice many deviations were allowed.

Hence, rather than using the External common tariff, we use the National tariff since it reflects better the protection levels actually felt by firms. It deviates from the External common tariff (ECT). We made an argument as to some degree of exogeneity of trade policy, based on the fact that the ECT was beyond the reach of bargaining power of domestic firms.

1. For smaller partners in Mercosur, (Paraguay and Uruguay), firms may have had little chance to influence the general convergence scheme. Olarreaga and Soloaga (1998) use a Grossman and Helpman “protection for sale” model for Mercosur external common tariff, and find it follows closely the Brazilian tariff structure.

2. It may be difficult for governments in developing countries to provide favors in the form of high-output tariffs because they are under the close scrutiny of international organizations, such as the International Monetary Fund (IMF). Instead, the political process of trade policy follows other paths.

There are many negotiated instances in which national tariffs deviate from the ECT: –Sector lists –Auto sector –Sensitive products These reflect mainly pressure of governments of small partners to reduce trade deviation due to high ECT, and not action from firms.

Paths used by firms to isolate themselves from the effects of opening to competition from the large trade partners’ economies 1. Bilateral preferences agreed with Argentina and Brazil. 2. Non-tariff barriers.

Bilateral tariff preferences with neighbors are likely to be endogenous. They are affected by exception lists, that become the subject of negotiation. However the partners are generally committed to eliminating them eventually.

Summing up: ECT it : External Common Tariff for item i in period t UNT it : Uruguayan National Tariff for item i in period t PA it, PB it :Residual tariff to imports of item i in period t from Argentina, Brasil AVE it : Ad valorem equivalent of non tariff measures item i in period t

Availability: ECT: Mercosur Secretary (HS) UNT it : NADE (Brussels) Classification HS PA it, PB it : ALADI database NALADISA Classification Mercosur Secretary, HS AVE it : OTRI database, selected years.

3. Protection data: matching with production data We have two product classifications in the Manufacturing and Activity surveys: based on ISIC rev 2 and based on ISIC rev 3. Also 2 item classifications in tariff data: Naladisa based on Brussels classification – Mercosur classification (HS)

We will produce a match between production and trade database codes to construct average protection for detailed item categories. Target: 6-digit and 4-digit HS aggregation level.

4. Protection data: aggregation The usual trade protection right hand side variables are (simple) averages of item tariffs (for instance ISIC 4-digit groups). Our argument is that excessive aggregation may fail to capture effects that operate within more narrowly defined markets.

Problem: choosing a suitable aggregation level to define the relevant protection measure to a firm. We will take the firm-level relevant protection level to be the simple average of tariffs for all (6 digit or 4 digit, we may try both) items that were ever produced by the firm along the whole sample period.

If we use averages of tariffs of close enough neighborhoods of products for each firm this might help to mitigate the endogeneity problem. i.e. a firm may try and get protection for its specific product, but generally might not obtain that for a near vicinity of products that might be substitutes for its own.

The usual argument is that production structure is endogenous to trade protection. We think this argument also holds when data are aggregated in broader cells of products. 6 digit or 4 digit HS level allows a much finer grid that captures probably better the relevant neighborhood of products for any firm.

Input protection: We use the input sheet in the manufacturing survey that records the input values using the same classification as the product sheet. The definition for the relevant firm-level input protection is parallel to that of product market protection.

5. Causal effect of protection on productivity: identification The usual measures of protection are most favored nation tariffs. We argue however that they do not tell the whole story, and there may be a role for bilateral preferences to shelter Uruguayan firms from competitors from large trade partners.

Based on Amiti and Konings (AER, 2007), we propose to estimate the following equation:

The effect of the MFN tariff coefficient can go either way. When there is a trade openness process with large neighbours, there may be two effects: Lowering barriers with the neighbours may have a productivity enhancement effect Raising barriers with countries outside the zone generates trade deviation effects

In general, the effect of the openness process on product markets will depend on the trade specialization of the firm and will be different for exporters, import substituting firms, etc. The same applies to the effect in the input markets with respect to import importing firms.

Variables describing protection in the final good markets should be interacted with export status /exports share. Variables describing protection in the input markets should be interacted with input importer status/ imported input share.

There are alternatives as how to measure product exporter or input importer status. A firm may not export but anyway benefit from the productivity effect of the openness process if belongs to a exporter sector. Hence the usual X/PV and M/Demand ratios can be calculated at the same aggregation level.

Exit dummy: an indirect way to assess whether underperforming firms are more likely to exit as trade liberalization proceeds. Other possible influences on between-firm evolution of total factor productivity: including firm-level characteristics as controls. Macro controls: RER (bilateral with neighbours, rest of world, etc.)