Trade Liberalization, Firm Performance and Labour Market Outcomes in the Developing World: What Can We Learn from Micro-LevelData?

imports of intermediates allow a finer division of labor which increases firms’ efficiency. A similar
reasoning applies to imports of differentiated capital goods. Further, through imports of interme-
diates and capital goods, domestic firms can benefit from foreign innovations incorporated in these
goods. This argument is particularly relevant for developing countries. In a dynamic extension of
Ethier (1982)’s model, Rivera-Batiz and Romer (1991) have also shown that, under certain con-
ditions (indeed quite restrictive), trade in differentiated intermediates can permanently increase
the rate of innovation and growth. Finally, as shown by Lee (1993), if capital goods are capital-
intensive, then trade liberalization reduces the price of capital goods in capital-poor developing
countries, thereby increasing the return to investment and the growth rate of capital stock in these
countries; similarly, trade liberalization reduces the price of imported technology in developing
countries, thereby stimulating technology advancement.

Foreign direct investment

Foreign investment can generate several benefits for the host country. For instance, it can
finance the expansion of industries in which the domestic country enjoys a comparative advantage.
Further, it can lead to the transfer of knowledge from foreign to local firms. Finally, it can provide
local firms with the critical know-how to break into foreign markets.

If foreign entrants possess a better technology, they can foster productivity improvements in the
domestic industry either directly, by raising the productivity of the resources used in production,
either indirectly through knowledge spillovers to local firms. As far as the latter effect is concerned,
local firms can learn from foreign firms either by simply observing them, or through turnover of
labor, as employees move from foreign to local firms.

Learning by exporting

It is often argued, mainly on the basis of anecdotal evidence, that there are several channels
through which domestic exporters can benefit from the technical expertise of foreign buyers.¹⁰ In
particular, breaking into foreign markets allows firms to acquire knowledge of international best

¹⁰See, inter alia, World Bank (1993).

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