Trade Reforms and Market Selection:Evidence from Manufacturing Plants in Colombia

We use plant output and input prices to decompose the profit margin into four parts:productivity, demand shocks, mark-ups and input costs. We find that each of these marketfundamentals are important in explaining plant exit. We then use variation across sectors intariff changes after the Colombian trade reform to assess whether the impact of marketfundamentals on plant exit changed with in creased international competition. We find thatgreater international competition magnifies the impact of productivity, and other marketfundamentals, on plant exit. A dynamic simulation that compares the distribution ofproductivity with and without the trade reform shows that improvements in market selectionfrom trade reform help to weed out the least productive plants and increase averageproductivity. In addition, we find that trade liberalization increases productivity of incumbentplants and improves the allocation of activity within industries....