Closing the Technology Gap: Does Trade Liberalization Really Help?

A common theme in discussions of trade reform is the possibility of improved technical efficiency following trade liberalization, This paper presents a conceptual analysis of the likely linkages between trade regimes and technical efficiency. Three sets of arguments, having to do with X-inefficiency, macroeconomic instability, and increasing returns to scale, are reviewed and found misleading or incomplete. A simple model of technological catch-up by a domestic firm shows the opposite of the usual argument: the larger market share provided by protection to the firm increases its incentives to invest in technological effort. When modified to include oligopolistic considerations at home, the model suggests that the incentives could go either way, depending on the mode of strategic conduct. The presence of economies of scale provides perhaps the strongest reason for productivity improvements, but here the argument relies on frictionless entry into and exit from industries. The paper concludes that the relationship between trade policy and technical efficiency is fundamentally ambiguous.