Input Reallocation within Firms

Abstract

This paper documents the within firm reallocation of inputs and outputs as a result of a trade policy shock on the input side. A unique firm-input level dataset for India with information on different raw material inputs used in production, enables us to identify firms with imported inputs subject to trade policy. To guide the empirics, we first develop a back-bone model of heterogeneous firms that source inputs from abroad. We find that affected firms engage in input reallocation and lower their use of protected inputs by 25-40%, relative to other inputs. Especially large firms and multi-output firms skew their input use towards unprotected inputs. To identify the output reallocation ensuing trade protection on inputs, we develop a firm level input-output correspondence. Firms reduce their sales of outputs made of protected inputs on average by 50-80%, relative to sales of other outputs. We find a firm level decrease in markups, suggesting that the cost of imported inputs is only partially passed through to output prices. Thus, this paper documents a new channel through which trade protection negatively impacts input-using firms.