Terms of trade and micro-foundations of economic growth: Evidence from firm-level TFP in China

Using matched data from the Chinese Industrial Enterprise Database and the Chinese Customs Database for 2000–2013, this paper constructs firm-level price-based terms of trade (TOT) and examines their impact on firm-level total factor productivity (TFP) in China. The empirical results reveal a statistically significant U-shaped relationship between TOT and firm-level TFP. Specifically, when TOT is in a relatively low range, an improvement in TOT is associated with lower TFP; however, once TOT exceeds a certain threshold, the marginal effect of TOT becomes positive. This finding remains robust to a series of robustness and endogeneity checks. Mechanism analyses further show that the nonlinear TOT–TFP relationship is strengthened by scale effects, eased financing constraints, and independent innovation, while technology lock-in weakens firms’ ability to transform favorable trade conditions into productivity gains. In addition, foreign direct investment (FDI) acts as an important conditioning factor in this nonlinear relationship. At lower levels of TOT, the role of FDI is more likely to be associated with crowding-out pressures on domestic firms, whereas beyond the threshold, spillover, linkage, and upgrading effects become more prominent, thereby strengthening the positive effect of TOT on firm-level TFP. Heterogeneity analysis shows that the U-shaped pattern is more pronounced among export-oriented firms, processing-trade firms, and firms located south of the Hu Huanyong Line. Overall, this paper provides micro-level evidence on how changes in trade conditions affect firm productivity and offers policy implications for promoting high-quality trade development and productivity growth in China.