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«Trade costs, Openness and Productivity: Market Access at Home and Abroad Arjan Lejour and Hugo Rojas Romasgosa and Victor Rodriguez and Carvos ...»

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Trade costs, Openness and Productivity:

Market Access at Home and Abroad

Arjan Lejour and Hugo Rojas Romasgosa and Victor

Rodriguez and Carvos Montalvo and Frans Van der Zee

European Commission - DG Enterpise and Industry

January 2009

Online at https://mpra.ub.uni-muenchen.de/21214/

MPRA Paper No. 21214, posted 9 March 2010 12:02 UTC

Trade costs, Openness and Productivity:

Market access at home and abroad Industrial Policy and Economic Reform Papers No. 10 Arjan Lejour Hugo Rojas-Romagosa Victor Rodriguez Carlos Montalvo Frans van der Zee Enterprise and Industry Directorate-General European Commission

Trade costs, Openness and Productivity:

Market access at home and abroad Arjan Lejour* Hugo Rojas-Romagosa* Victor Rodriguez** Carlos Montalvo** Frans van der Zee** 26 January 2009 * CPB Netherlands Bureau for Economic Policy Analysis. Contacts: arjan.lejour@cpb.nl and h.a.rojas@cpb.nl ** TNO Innovation Policy Group. Contacts: victor.rodriguez@tno.nl, carlos.montalvo@tno.nl, frans.vanderzee@tno.nl This project is carried out within the Framework Service Contract B2/ENTR/05/091 – FC. The authors thank Josefina Monteagudo for her constructive comments and helpful ideas in particular in suggesting data and research questions in section 4 of this paper. We are grateful to the European Commission for access to the survey data Observatory of European SMEs. Arjan Kneppers provided useful research assistance. We also thank the participants of the meetings in Brussels and the CPB colleagues Henri de Groot, Albert van der Horst and Bas ter Weel for useful comments.

Industrial Policy and Economic Reforms Papers are written by the staff of the Directorate General for Enterprise and Industry or by experts working in association with them. This publication series aims to raise the awareness and stimulate the debate on issues in the areas of industrial policy and economic reforms. Views expressed in these papers represent the positions of the authors and do not necessarily reflect those of the European Commission or the CPB Netherlands Bureau for Economic Policy Analysis.

Contact information European Commission Enterprise and Industry Directorate-General Unit B4 – "Economic Analysis and Evaluation" Rue de la Loi / Wetstraat 200 B-1049 Brussels Tel: (32-2) 295 49 39 Fax: (32-2) 297 41 23 E-mail: entr-economic-analysis-and-eval@ec.europa.eu

Web page:

http://ec.europa.eu/enterprise/enterprise_policy/competitiveness/3_indpol/industrial_policy.htm A great deal of additional information on the European Union is available on the internet.

It can be accessed through the Europa server http://ec.europa.eu ISBN-13: 978-92-79-11485-4 ISSN: 1831-0672 DOI: 10.2769/43314 Luxembourg: Office for Official Publications of the European Communities © European Communities, 2009 Reproduction is authorised provided the source is acknowledged.

Abstract This paper discusses the channels between openness and productivity and trade hampering factors. The stylized facts from the heterogeneous firms literature suggests that firms face market entry costs for each new product they export and to each new export market. Transport costs, border costs and retail and wholesale distribution costs might add up to 170% of the export value, but formal import tariffs and duties are relatively unimportant. The results by the Observatory of European SMEs survey, which has firm-level data for the whole European Union confirm this result. Lack of knowledge on export markets and regulations in other countries are important trade barriers for European firms. From these outcomes it could be derived that EU trade policies should be directed to deep integration with other countries, preferably by implementing internal market policies for goods and services trade and foreign direct investment. These policies can deal with reducing regulations heterogeneity, non-tariff barriers and customs procedures. Providing public information on export markets (e.g.

customers, contact, and distribution networks) could also be helpful, if well targeted.

Key words: Openness, productivity, heterogeneous firms, innovation, trade costs, trade policy JEL codes: F1, F13, F15 Contents

–  –  –

There is massive empirical evidence that open economies are richer and more productive than closed economies: one percentage point increase in the share of trade in GDP raises the level of income in the range of 0.9 to 3 percent. Openness in terms of trade or foreign direct investment benefits the economy, but it is less clear which factors hamper openness, which polices promote openness and how more openness leads in the end to higher productivity and income. This paper identifies which factors hamper trade and which of them are policy related. Second, it discusses the relevance of the main channels of more openness to productivity.

These questions are not new, but this paper examines them from a different perspective: the heterogeneous firm literature that uses firm-level data. This new literature has shown that firms are very heterogeneous, not only in size, capital intensity and R&D intensity but also in export and import performance. Moreover, multinationals are even more productive than exporters. Thus, foreign direct investment also differs much between firms, as well as the importance of capital and knowledge spillovers. The stylised facts on this literature are used to discuss the channels between openness and productivity and trade hampering factors. The most productive firms are responsible for most exports and imports, but exporting itself does not seem to raise firm productivity substantially in developed countries (only aggregate productivity). Firms face market entry costs for each new product they export and to each new export market. This suggests the existence of fixed market entry costs, which can only be overcome by ex-ante higher productivity levels. The consequence would be that firms have to increase productivity years before they start exporting, although this is still under investigation.





Innovating firms export on average more than non-innovating firms, which in turn often constraints to finance innovations. For smaller countries access to foreign knowledge is very important, and this is usually attached to imported inputs and spillovers from FDI. Moreover, exports could be stimulated by the protection of intellectual property rights in countries in which the risk of imitation is fairly high.

Trade hampering factors are discussed in the context of trade costs. These consist of transport costs, border costs and retail and wholesale distribution costs. For EU countries these might add up to 170% but formal import tariffs and duties are relatively unimportant in total trade costs. This result is confirmed by the Observatory of European SMEs survey, which has firmlevel data for the whole European Union. Lack of knowledge on export markets and regulations in other countries are important trade barriers for European firms. In addition, they perceive internal market policies as very helpful for doing business abroad because of simplified customs procedures, a common currency and standardised regulations.

In the past, decreasing trade costs where often the result of lower transport costs and formal import tariffs and duties. Our results and those from the heterogeneous firms’ literature suggest that EU trade policies should be directed to deep integration with other countries, preferably by implementing internal market policies for goods and services trade and foreign direct investment. These policies can deal with reducing regulations heterogeneity, non-tariff barriers and customs procedures. The recently established Transatlantic Economic Council and deep regional trade agreements between the EU and some Asian countries pursue this line of thought.

Providing public information on export markets (e.g. customers, contact, and distribution networks) could also be helpful in reducing the lack of information by SMEs. This could increase exports at the extensive margin (i.e. when non-exporters to become exporters and exporters enter new export markets). It is the entrance to markets where the difference could be made; this. This is more effective than efforts to increase the export volumes to current markets. Export promotion policies should be well targeted and should not apply to very productive firms which already managed to overcome these entry costs. It is also ineffective to support very low productivity firms, because the support will not transform them into exporters or importers. Policies should be targeted to firms whose productivity is just too low to overcome market entry costs. It has to be taken in mind that these policies should not only be directed towards improved market access abroad but also at Europe’s home market.

Imports are at least just as important as exports for raising productivity and income.

1. Introduction

The post-World War II era has been characterized by high growth rates in the world economy and a progressive reduction in barriers to international trade and investment. Productivity increases in agriculture and manufacturing, and more recently in services have been a major driver in the generation of income and wealth. There is massive empirical evidence that open economies are richer and more productive than closed economies. In an overview of studies about the income effects of openness Lewer and Van den Berg (2003) found that a percentage point increase in the rate of growth of international trade increase the growth rate of the economy by about 0.22%. It is hard to believe this is a permanent increase, but even if the income growth effect dies out after 10 years, income is about 2.5% larger. For high income countries, like the EU, Lewer and Van den Berg (2003) found that the effect is twice as large, although this result is based on only 30 studies. Other recent studies focussing on the income level found similar effects: one percentage point increase in the share of trade in GDP raises the level of income in the range of 0.9 to 3 percent.1 The link between openness and income is convincing but it is more difficult to establish an empirical link between trade policy and income.2 Moreover, it is hard to identify empirically which factors limit openness and the accompanying productivity gains. The theoretical channels between openness and productivity are clear (such as reallocation of resources, more competition, economies of scale, bigger variety of products, innovation, and knowledge spillovers), but their quantitative importance less so. Two questions come to the fore. First, which factors hamper trade and which of them are policy related. Second, what are quantitatively the main channels from increased openness to productivity? From a policy perspective the question is: Can the European Union (and the Member States) implement policies to increase openness and the benefits from the induced increase in productivity?

Most of the policy advices to liberalise trade are based on macroeconomic or sectoral analyses. Recently, trade economists have shifted their focus towards the characteristics and trading behaviour of individual firms. This new approach is better known as the heterogeneous firms’ literature. This literature has shown that firms are very heterogeneous, not only in size, capital and R&D intensity but also in export and import performance.

Examples are Badinger (2005), Frankel and Romer (1999), Frankel and Rose (2002), Wacziarg and Horn Welch (2003) and the overview of Nordas et al. (2006).

See Nordas et al. (2006) and Wacziarg and Horn Welch (2003)), among others.

Moreover, foreign direct investment (FDI) also differs a lot between firms, including the importance of capital and knowledge spillovers.

We use this literature to address our two research questions. It deals specifically with the behaviour of individual firms that take decisions on (foreign) investment, innovation, imports and exports. We also study if they experience (or not) trade and investment barriers and how they respond to these barriers. In the past these differences between firms were often not considered, so if they do respond differently to these trade and FDI constraints then we can obtain new policy insights regarding openness and productivity.

In section 2 we discuss the channels between openness and productivity. Section 3 presents stylized facts on the trading and foreign investment behaviour of heterogeneous firms. In particular, the empirical relations between firm productivity and innovation, productivity and trade, and innovation and trade are presented, including the role of multinationals and knowledge spillovers. It concludes that firms face market entry costs at each new export market and for each product. Firms’ productivity has to be high to overcome these costs.

Section 5 discusses some policies to lower these entry costs.

The trade hampering factors are discussed by analysing trade costs in section 4. First, the economic literature is used to classify all possible trade costs. Second, we analyse the importance of trade hampering factors for EU firms using the Observatory of European SMEs firm-level survey. One of the main conclusions is that lack of knowledge on export markets and regulations in other countries are the main trade barriers. Import tariffs and duties are less important. In addition, EU firms perceive the internal market as very helpful for doing business abroad because of simplifying customs procedures, a common currency and standardised regulations. These results suggest that EU trade policies should be directed to deep integration with other countries, preferably by implementing internal market policies for goods and services trade and foreign direct investment.

2. Transmission channels between openness and productivity

The relation between openness and productivity is a widely researched topic at the macroeconomic level. Many studies have focussed on the empirical relation in particular between trade liberalisation and income.3 Many of these cross country studies conclude that Edwards (1998) and Lopez (2005) provide some overviews.



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