Imported Inputs, Quality Complementarity, and Skill Demand

Abstract

This paper analyzes how access to imported inputs affects firms in developing countries, where domestically produced high-quality inputs are relatively costly. We build an O-Ring type model with quality complementarity across input tasks, ranking tasks by their quality sensitivity. Because high-quality inputs are relatively cheap in international markets, firms use these instead of domestic inputs for quality-sensitive production steps. This substitution effect lowers the demand for domestic input quality (such as skilled labor), while it raises output quality. At the same time, the complementarity effect increases the return to quality in the remaining domestic tasks. This raises output quality further; it also increases the demand for domestic input quality (skills), counterbalancing the first effect. To provide evidence for this mechanism, we match high-resolution data from Chilean customs to a large firm-level panel for the period 1992-2005. In line with the model’s predictions, importers use ceteris paribus a lower share of skilled workers, while their skill demand increases significantly with the quality of imports.