The elusive impacts of tariff reduction on firm selection

The multi‐sector Melitz model predicts that unilateral trade liberalization leads to stronger selection effect and hence more pronounced industrial productivity growth in the non‐liberalized sectors, which is contrary to the empirical evidence that industrial productivity increases more in the liberalized sectors. This phenomenon is referred to as the ‘Melitz‐Trefler puzzle’. In this paper, we exploit the unique episode of China's entry into WTO and unpack the sources of the relative productivity growth in the liberalized sectors. More specifically, we show that the aggregate industrial productivity growth can be driven by either the ‘selection effect’ or the ‘shift effect’. Our empirical results suggest that the aggregate industrial productivity growth following tariff reduction is mainly driven by the ‘shift effect’ rather than the ‘selection effect’; further, the impacts of tariff reduction on the firm selection exhibit sharp industry heterogeneity, with the effect positive for industries far away from the technology frontier, and those with low technology and low R&D intensity, while negative for otherwise.