Trade liberalization and quality upgrading: Third-country effects

Abstract

This paper theoretically and empirically shows that trade liberalization can have serious effects on firms within a third country which was not party to the trade liberalization, but which previously benefited from the trade barrier in trading with the liberalizing country. The liberalization increases competition for exporters in the third country, just as it does for firms in the liberalizing country. When a policy of liberalization is implemented towards a country that specializes in low quality products, mid-productivity firms respond by upgrading the quality of their exports to escape intensified competition. I empirically test this theoretical finding by analyzing how Turkish firms responded to the elimination of EU quotas on China in 2005. Following this trade liberalization, the unit value of the products exported by mid-productivity Turkish firms to the EU increased by 8 percentage points more than that of the control group. This upward adjustment in the unit value of exports was accompanied by a 3 percentage point increase in the average unit value of imported inputs.