Impact of trade on industry-level output

Abstract

This study examines whether a country's trade significantly increases industry-level output and whether this impact is greater for industries with higher levels of differentiation. To empirically answer these questions, the Frankel and Romer [(1999). “Does Trade Cause Growth?” American Economic Review 89 (3): 379–399] method, which uses the geographical component of trade as an instrument, is extended in two ways. First, the study examines the impacts on industry-level output instead of country-level output. Second, an index of industry differentiation based on Rauch [(1999). Networks Versus Markets in International Trade.” Journal of International Economics 48 (1): 7–35] is introduced. Using a two-stage least squares estimation and data for 20 manufacturing industries and 99 countries in 2015, it is found that the impact of a country’s trade on industry-level output and output per worker is heterogeneous across industries. A one-percentage-point increase in the trade/GDP ratio results in a larger effect for industries with higher degrees of differentiation, ranging from 0.340% to 1.736% for industrial output and from 0.754% to 1.566% for industrial output per worker. This heterogeneity with respect to industry differentiation is robust even when controlling for latitude and institutional variables. These results suggest that a country’s trade affects industry-level output differently depending on the industry’s level of differentiation.