Monday, January 16, 2012

Services liberalization and productivity of manufacturing firms: evidence from Ukraine

In the 2000’s, services sector in transition countries experienced rapid development due to major regulatory changes. Deregulation allowed new firms to enter the market resulting in rapid expansion of services as a share of GDP. The focus of this paper is on analyzing the impact of those changes on productivity of manufacturing firms. This question has recently received considerable attention due to the importance of services in the global economy and due to the ongoing debates on the Doha Agenda (Hoekman et al., 2010). The literature documents a positive effect of services deregulation on productivity of manufacturing firms in the Czech Republic (Arnold et al., 2011) and in Chile (Fernandes and Paunov, 2011). Still, as pointed out by Francois and Hoekman (2010), works that try to establish a causal link from services to increase in productivity are plagued with the endogeneity problem and with the problem of disentangling the effect of services liberalization reform from the effect of other reforms. We look at the episode of services liberalization in Ukraine in 2001-2007, which was isolated from other major deregulatory changes and was driven by political pressure imposed by trading partners as a precondition for the Ukrainian WTO accession.

We exploit rich data on Ukrainian manufacturing firms, which allows us to construct a firm-specific index of the services use intensity and interact it with sub-sector and timevarying indices of services liberalization provided by the European Bank for Reconstruction and Development (EBRD). We adopt the standard two-stage approach in the literature of estimating the effect of a policy change on productivity (Pavcnik, 2002; Javorcik, 2004; Amiti and Konings, 2007; Khandelwal and Topalova, 2011). At the first stage, we estimate the production function using the Olley-Pakes methodology (Olley and Pakes, 1996), controlling for demand shocks as suggested by De Loecker (2011), to extract total factor productivity (TFP) of manufacturing firms. At the second stage, we regress TFP on the firm-specific index of services liberalization, controlling for the firm-specific heterogeneity and market structure of manufacturing industries. As a new contribution, we also implement a onestage procedure of estimating the effect of the services liberalization on productivity, which takes into account a dynamic effect of liberalization on investment decisions and, as a result, on exit and entry of firms.

Using the standard method, we find that a standard deviation increase in our measure of services liberalization is associated with a 9 percent increase in productivity. The size of the effect is stronger then in previous studies, probably reflecting the fact that the Ukrainian services sector before the reform was less developed than in the Czech Republic and Chile. The effect is stronger for domestic and small firms, which makes services liberalization a very useful tool for local policymakers interested in promoting growth of domestic small and medium enterprises. Allowing for the dynamic effect of services liberalization on current investment decisions and on future productivity further reinforces the effect of services liberalization on productivity in manufacturing industries. We also document the uniformly positive but heterogeneous in size impact of the reform across manufacturing industries.

We find that the effect of the reform is stronger for more aggregated data, reflecting the two sources of increase in productivity at the industry level. First, the reform increases within firm productivity as described in the previous paragraph. Second, the reform leads to exit of low productivity firms and induces entrance of new competitors due to the general equilibrium effect of liberalization (see Olley and Pakes, 1996; Melitz, 2003), which further increases industry productivity.

The structure of the paper is as follows. Section 2 places this study within the existing literature. Section 3 describes progress of the services sector liberalization in Ukraine in 2001-2007 and its impact on the services sector. Section 4 discusses data, methodology and results. Section 5 concludes.

World Bank. Author: Shepotylo, Oleksandr ; Vakhitov, Volodymyr.Document Date: 2012/01/01.Document Type: Policy Research Working Paper.Report Number:WPS5944

Services liberalization and productivity of manufacturing firms: evidence from Ukraine x

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