Regional Integration and Productivity: The Experiences of Brazil and Mexico Ernesto López-Córdova and Mauricio Mesquita Moreira Inter-American Development Bank August 2003

Motivation What integration does to productivity is a key concern in a region where sustainable growth has been an elusive goal. The literature on trade and productivity does not cover recent agreements nor the implication of different integration strategies. The experiences of Mexico and Brazil might provide important clues about the productivity effects of the FTAA.

Overview Literature review of the links between integration (trade and FDI) and productivity (TFP). Main facts of Brazil and Mexico’s integration strategies. Econometric analysis of the impact of integration on productivity based on plant level, manufacturing data. Mexico post-NAFTA ( ) and Brazil post-stabilization ( ).

What is the Theory? Main Integration-Productivity Channels: Trade Foreign Direct Investment

The Trade Effects: Macro comparative advantage scale knowledge Micro input availability knowledge spillovers import discipline higher turnover

The FDI effects: entry competition knowledge spillovers linkages

What is specific about regional integration? The trade channel might operate differently. Comparative advantage: risk of trade diversion, particularly in south-south type of agreements. Scale: potential gains are higher in a non- preferential liberalization but so are the potential losses. Knowledge effects: might reduce the risk of the dislocation of learning/innovation intensive sectors, but might restrict producers access to the best practice.

What is the evidence in Latin America ? Macro level: disappointing… IDB (2001): TFP  0.6 % a year in 1990s Baier et al. (2002): TFP  2.9 % in 1990s. …but there is some hope coming from sector and firm level data

Manufacturing labor productivity (1990=100)

Firm level data TFP Growth: Tybout and Westbrook(1995): Mexico ( ) = 1.8% Pavnick (2000): Chile ( ) = 2.8% Muendler (2002): Brazil ( ) = 0.4% Aw, Chen and Roberts (2001): Taiwan ( ) = 3.2% Causality Trade: Strong Evidence of the import discipline effect. FDI: Some evidence of the prevalence of vertical over horizontal spillovers (Aitken and Harrison 1999, Kugler 2000)

Brazil and Mexico: stylized facts

Estimating Productivity: Strategy Measure TFP using firm- or plant-level data Allow for firm heterogeneity Compare performance by plant category (foreign ownership, exporters, etc.) Control for unobserved firm characteristics....but, intensive data requirements Present aggregate measures of TFP performance. Explore determinants of firm-level TFP performance. Tariffs, FDI, exporting activities, input availability

TFP Estimation: Data Brazil: Panel of 10,900 firms, Mexico: Panel of 5,700 plants, Data: Inputs, K-stock, investment, shipments, some plant characteristics Industry-level data on tariffs, trade, FDI Industry-wide price deflators Foreign ownership Trade and tariff data at detailed HS level Aggregate weighing by imports or US exports to ROW

TFP Estimation: Methodology Cobb-Douglas production function: y it =  o +  l l it +  s s it +  m m it +  k k it + lnTFP it +  it OLS estimation yields biased estimates Sample selection due to attrition Simultaneity in TFP and input choice Solution: Olley-Pakes (Ec. 1996) Firms observe TFP shock, decide to stay or exit. If firm stays, then it chooses investment (thus capital) based on observed productivity shock.

Brazil: Annual TFP Growth

Mexico: Annual TFP Growth

Aggregate TFP Results TFP growth might vary to the extent that regional integration differs across industries. However, other factors might be behind TFP growth (e.g., high tech vs. low tech industries) Nonetheless, outward oriented industries firms exhibit faster TFP growth in both countries. Import-competing or exporting vs. non-traded industries In Mexico, foreign-owned plants

Brazil: Annual TFP Growth By Industry/Plant Characteristics,

Mexico: Annual TFP Growth By Industry/Plant Characteristics,

Productivity Decomposition Within-plant TFP growth or resource reallocation toward more efficient producers? TFP decomposition: Within-plant TFP gains Within-industry reallocation Reallocation across industries Results Reallocation is a major force behind productivity growth Intra-firm gains in outward-oriented industries/firms

Brazil: Productivity Decomposition

Mexico: Productivity Decomposition

Integration and TFP: Econometric Strategy Estimation equation: ijt = ijt + ijt + TFP ijt =  t TRADE ijt +  f FDI ijt + controls + ijt Trade variables: Import competition: World tariffs, imports/output Market access: Preferential treatment in US over ROW (Mexico) Exporting activities: Exporter dummy, exports/sales Increased availability of imported inputs: Inputs/Costs FDI: Foreign K in plant’s own industry (horizontal spillovers); and In industries that buy/sell inputs to plant’s industry (vertical spillovers)

Integration and TFP: Econometric Strategy Controls: Age, age squared, size, industry output, capacity utilization, industrial and geographic concentration, U.S. consumption, ln(XR*US PPI), and year dummies. Unobserved plant characteristics  Fixed effect. Endogenous trade variables  2SLS, IVs. For Mexican and US tariffs: NAFTA negotiated tariffs For import penetration: Fitted import values from a gravity equation

Productivity and Integration: Summary of Results

Conclusions Sizeable productivity gains from integration in both Brazil and Mexico (mainly from trade and from import discipline). Signs that North-South integration was a more powerful boost to trade and productivity than its South-South counterpart. How much of these gains were level or growth effect is difficult to tell.