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

by individual firms (taking the output of rivals as given) implies the following mark-up pricing rule:

σn 1

p =----T-

σn — 1 φ

Equation (2) is crucial for understanding the pro-competitive effect of trade liberalization. It shows
that a firm’s price-marginal cost mark-up, σnnT, depends negatively on the perceived product
demand elasticity, σn. Thus, when firms face a fiercer competition due to a rise in the number (n)
of rivals, they perceive a higher demand elasticity and consequently lower their mark-up.

With unrestricted entry, profits (π) are zero in equilibrium:

∏ = (p — 1∕φ)q — f = 0 ⇒ q = fφ(σn — 1)                     (3)

Finally, full employment of labor (L) requires:

L = nl = n(f + q/φ)                                (4)

where l = f + q∕φ represents labor employed by each firm. Solving equations (3) and (4) for n
and q gives:

1                         Γ                1 "I

■=fe) ²∙='∙f)²∙'                 »

It can be shown that trade integration among countries with similar tastes and technology is
formally equivalent to an increase in the size of the economy, as captured by an increase in L. The
effects on firm performance are straightforward:

1) Equation (5) shows that trade integration (i.e., a rise in L) raises the number of firms ■.
From (2), this implies that firms perceive a higher demand elasticity and hence lower their price
and mark-up. This is the pro-competitive effect of trade integration.

2) Trade integration raises firm size q (see equation (5)).

3) The trade-induced increase in firm size raises firm productivity (given by q/l) due to a better

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