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

practice. Further, foreign buyers often provide their suppliers with technical assistance and product
design in order to improve the quality of imported goods. It has also been noted that in some
cases foreign buyers transmit to their suppliers located in low-wage countries the tacit knowledge
acquired from their other suppliers located in technologically advanced countries. Hence, exporting
may foster learning and productivity growth.

Aside from these beneficial effects, trade liberalization has also been argued to have potentially
negative dynamic effects for developing countries. These negative effects can be thought of as the
dynamic counterpart to the static gains from specialization based on comparative advantage. For
instance, as shown by Lucas (1988) and Young (1991), in the presence of sectoral asymmetries in
the relevance of learning-by-doing, a developing country which in the free trade regime switches
its production mix toward technologically stagnant sectors may suffer a permanent reduction in
its rate of productivity growth. Similarly, Grossman and Helpman (1991) have shown that trade
liberalization can adversely affect the rate of innovation and growth in a human capital-poor
developing country by diverting its resources away from R&D. Further, Rodrik (1988) argues that,
if firms invest in superior technology to reduce their costs, then their incentive to invest depends
positively on output. It follows that trade liberalization may reduce the incentive to invest in new
technology for firms belonging to the import competing sectors, since these sectors should contract
after trade liberalization.

In the previous section, we have already shown that there is evidence of trade-induced produc-
tivity gains in the developing world, and that these gains are larger for import competing firms.
Hence, the available micro-level evidence suggests that the potentially negative effects of trade
reforms are actually offset by their positive effects. In section 7, we will report more micro-level
evidence on the effects of trade reform in India. In the rest of this section, we discuss the empirical
relevance of some of the mentioned channels of international technology diffusion.

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