Conclusion
This paper studies the relationship between quality and productivity under trade liberalization and highlights the heterogeneous response across firms to import tariff reductions. We use highly disaggregated firm-product-level data and the shock of China’s entry into the WTO to trace through the manner in which trade liberalization on intermediate inputs induced Chinese firms to upgrade their input and output quality. We find that quality upgrading is primarily achieved by the initially less successful Chinese firms. In other words, the chief beneficiaries of liberalized intermediate input tariffs are not the initially most productive firms but are instead the less productive firms that are operating in industries in which the scope for quality variation is the most pronounced. When initially more capable firms run into diminishing returns to quality upgrading, it is precisely those lower productivity firms that are most likely to upgrade the quality of their exports, increase the quality of their imported intermediates, and upgrade their workforces. They are also more aggressive in entering new, high income markets where demand for high quality goods is strong along the extensive margin. As a result, the gap between low and high productivity firms regarding their quality performance would be reduced under an import tariff reduction. In this sense, trade liberalization appears to have evened the playing field with respect to firm performance.
