The Effect of Tariff Reductions on Firm Size and Firm Turnover in Canadian Manufacturing

Recent evidence suggests that tariff reductions from the Canada-U.S. Free Trade Agreement (FTA) generated substantial productivity gains in Canadian manufacturing. Using a comprehensive panel data set of 81 manufacturing industries over the 1983-1996 period, we shed new light on two potential sources of these productivity gains: increased firm size and increased firm turnover. Our empirical results confirm previous empirical findings that increased firm size was not a source of the FTA-induced productivity gains, contrary to the predictions of early theoretical models. However, we find support for the hypothesis that tariff reductions affected productivity growth through its effect on firm turnover. Our empirical results show that the FTA tariff reductions had a positive and significant effect on the exit rate of manufacturing firms. The estimated impact of the tariff cuts was an increase in the exit rate of 0.7 to 2.0 percentage points for the most affected industries over the 1988-1996 period. Supplementing this finding with recent research showing that exiting firms tend to be less productive than those that survive, this provides support for recent trade models asserting that increased exposure to international trade induces the exit of least efficient firms, thereby contributing to productivity growth