in five import competing sectors.28 They use firm-level data taken from CMIE. The data cover the
period 1987-1993. Similar to the results from previous studies, they find no significant employment
effect of trade reform overall and in each of the five sectors studied. More interestingly, the authors
formulate and test a specific explanation for the lack of employment contraction in the import
competing sectors. They argue that, in the presence of imperfect competition, trade liberalization
raises firms’ perceived product demand elasticity and hence induces them to lower mark-ups and
expand output. Hence, the pro-competitive effect of trade liberalization may involve an increase
in the demand for labor. This effect may partially offset the labor demand reduction in import
competing sectors induced by the forces of comparative advantage.29
In order to test this prediction, Kambhampati et al. (1997) estimate the following equation:
lit = β0 + β1ωt + β2 θit + β3kit + β4mit + β5D + εit
(23)
Here, l, ω, θ,k and m are the natural logs of L, w/P, Θ,Kand M, respectively; D is a liberalization
dummy, which takes a value of zero for the years 1991 and before and a value of 1 for the years after;
ε is a stochastic error.30 The regression results reported by the authors, obtained by using the
random-effect estimator, show that, overall and in four of the five sectors studied31 , both the real
wage and the mark-up are negatively and significantly correlated with firms’ labor demand. This
evidence suggests that when the import competing sectors of a liberalizing country are imperfectly
competitive, then the output contraction in these sectors (and the consequent short-run surge in
unemployment) may be much less dramatic than expected in the light of the traditional trade
theory.
28The five import competing sectors are: Electronics, Electrical machinery, Non-electrical machinery, Transport
equipment and a sector that only includes firms that produce Diversified products.
29 See also Harrison and Hanson (1999) on this point.
30The first order conditions for profit maximization imply that the demand for both K and M is a function of
L. Hence, there is a simultaneity problem in the estimation of the labor demand equation. In order to correct for
this endogeneity of capital and materials, the authors use as instrumental variables the predicted values of K and
L obtained by regressing them on a set of exogenous variables.
31 Results for the sector producing Diversified products turn out to be statistically insignificant.
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