Foreign competition, imported inputs and firms’ decisions

We extend the trade model with firm heterogeneity developed by Melitz and Ottaviano (2008), incorporating domestic and imported intermediate goods, in order to investigate the impact of import barriers on final and intermediate goods on firms’ decisions to produce and to export. Our main contribution is to disentangle the channels through which these trade policies work. When variable trade costs for final goods go down, there is an increase in the number of foreign firms selling on the domestic market (import competition channel). Changes in intermediate good import barriers influence the relative price of factor inputs affecting the competitiveness of domestic firms (factor cost channel). Using a dynamic model specification, we provide empirical evidence in support of the model’s predictions based on plant-level panel data from Chile (1990-1999) and Argentina (1992-2001).