Exporters in Developing Countries: Adjustment to Foreign Market Access after a Trade Policy Shock

This paper estimates the short-run impact of an unexpected foreign trade liberalization shock on exporting firms and product-level data from a developing country. The economic environment was created when major importers such as the U.S., EU and China imposed new safeguard trade barriers in 2002 on steel imports deriving from developed countries and implicitly provided developing country exporters an unexpected preferential market access shock of up to 30% by exempting them from the barriers. We use firm-level data to estimate the differential impact of this trade liberalization shock on Indian steel firms and the products they produce. We provide evidence that Indian firms with historic export ties to these markets responded more quickly to the changing market conditions in order to increase sales, exports and profits. Furthermore, we present evidence of hysteresis – i.e., exports continue to expand even after the termination of the preferential market access conditions via the removal of the discriminatory import restrictions. In terms of firm-level use of inputs, while the Indian firms that produce these preferenced products increased capacity utilization on average, the historic exporters responded more quickly by making new investment to expand existing capacity. Finally, our data also allows us to explore the role of product-switching to examine characteristics and behavior of firms that entered into these new preferenced-product categories. Entry into these new products was predominantly undertaken by larger firms that had previous experience exporting other types of steel products, a result with implications for understanding how firms overcome the fixed costs of exporting.