Processing trade, firm´s productivity, and tariff reductions : evidence from Chinese products

This paper explores how reductions in tariffs on imported inputs and final goods affect firm productivity by exploiting the special tariff treatment that processing firms apply on imported inputs as opposed to those of non-processing firms. Highly disaggregated Chinese transaction-level trade data and firm-level production data from 2000 to 2006 are used to construct firm-level input and output tariffs. Careful examination of the extent of firm engagement in processing trade and in controlling for various sources of endogeneity reveal that less productive firms choose to engage in processing trade. More importantly, unlike previous findings, reductions in output tariffs have a greater effect on productivity improvement compared with reductions in input tariffs due, in large part, to the fact that processing trade in China enjoys zero tariffs on imported inputs.