Principal investigator: Bruno Benevit
Original title:
Authors: Matteo Fiorini, Marco Sanfilippo and Asha Sundaram
Location of the Intervention: Ethiopia
Sample Size: 12.672 firms per year
Sector: Transportation Economics
Primary Variable of Interest: Total Factor Productivity
Type of Intervention: Tariff reduction
Methodology: TW-FE, Logit
Summary
Transportation infrastructure is essential for economic development, directly influencing firm productivity. Similarly, tariffs play a fundamental role in the commercial expansion of countries. Ethiopia experienced a reduction in import tariffs and investments in highways from the 1990s onwards, allowing for an assessment of the combined effects of these reforms. This study analyzed how this liberalization of inputs affected the productivity of Ethiopian firms, considering the complementary role of road infrastructure. Using geospatial data on the road network and industrial censuses between 1998 and 2009, the authors applied different econometric models considering various market and infrastructure factors of the firms. The results indicate that, in isolation, tariff reductions have little effect on productivity, but a significant increase in the use of imported inputs and the adoption of productive technologies was observed when accompanied by road improvements. Firms in more connected locations also face greater competition, which intensifies incentives for efficiency. Additionally, the gains are more significant in previously isolated areas, highlighting the role of roads in spreading the benefits of trade liberalization.
- Policy Problem
The relationship between trade liberalization policies and the productive performance of companies has been a recurring theme in the economic development literature. Opening up to trade, especially through the reduction of tariffs on intermediate inputs, can boost productive efficiency by facilitating access to cheaper, more diverse, and technologically superior inputs (Fiorini; Sanfilippo; Sundaram, 2021). Furthermore, exposure to international competition encourages the adoption of innovations and more competitive practices. However, the gains from this strategy do not occur automatically or homogeneously, often being conditioned by factors internal to the country, such as the quality of institutions and the availability of infrastructure.
Studies such as those by Topalova and Khandelwal (2011) and Bloom et al. (2016) have demonstrated that the positive effects of trade liberalization on productivity vary according to the domestic environment. The efficiency of labor markets, access to credit, and especially transport infrastructure are decisive elements in this process. In low-income countries, where physical access to markets is limited, the impact of trade reforms can be restricted or amplified by regional connectivity. This suggests that infrastructure functions as an additional channel for the diffusion of the benefits of economic openness.
In Ethiopia, the combination of progressive reductions in tariffs on industrial inputs since the 1990s and a robust road expansion program offers a unique opportunity to investigate this dynamic. The country has invested heavily in roads through the Road Sector Development Program (RSDP), while simultaneously undergoing a process of trade liberalization driven by external agents. This context allows us to observe how intranational connectivity influences the ability of companies to incorporate imported inputs and adapt their operations. Understanding this relationship is fundamental to designing more effective and equitable development policies, especially in economies facing severe logistical constraints.
- Policy Implementation Context
Tariffs directly impact the productivity of firms. In the context of Ethiopia, the reduction of tariffs on imported intermediate inputs decreases the cost of acquiring raw materials and components used in production. This decrease depends on the degree to which the reduced tariffs are passed on to domestic prices, which is directly influenced by the quality of the road network. Paved and well-maintained roads cut travel time, reduce the frequency of breakdowns, and lower transportation expenses for distributors and wholesalers. Thus, faster and safer routes increase the margin for passing on the savings generated by lower tariffs, allowing firms to benefit from cheaper inputs. The efficiency of the road system, in this sense, reinforces the scope of tariff liberalization and its effect on Total Factor Productivity.
The expansion of the road network also broadens the reach of domestic markets, connecting producers to new consumer regions and sources of supply. With better roads, local competition increases, as more companies can access previously isolated areas and compete for market share. This competitive environment encourages leaner organizational practices, incentives for employee training, and the adoption of more efficient production processes. By combining reduced input costs with greater competition for customers, firms tend to adjust their industrial plants, revise workflows, and diversify products. These measures contribute to increasing total factor productivity (TFP), reflecting gains in scale and management.
Beyond impacting prices and competition, quality roads facilitate investments in advanced technologies. The ease of transporting imported parts and equipment encourages partial or total automation of production lines and the incorporation of digitally assisted processes. These innovations expand the technological frontiers of firms, allowing for more productive combinations of capital and labor. The interaction between reduced import tariffs and high-standard road infrastructure creates a favorable environment for the adoption of modern machinery and improved production methods. As a result, physical productivity captures not only cost reductions but also the technological evolution of industrial establishments.
- Evaluation Details
Ethiopia's road network is characterized by an extensive but historically under-equipped network: of approximately 112,000 km of roads, less than 20% were paved until the mid-1990s. The lack of systematic investment resulted in low road density and critical seasonal accessibility during the rainy season. Starting in 1997, the government launched the RDSP (Rehabilitation and Development of Federal and Regional Roads), divided into three phases until 2010, which mobilized national and international resources to rehabilitate federal and regional road sections. Between 1997 and 2010, the proportion of paved roads in good condition jumped from 17% to 73%, reducing logistical costs and expanding inter-regional integration.
To analyze the impacts of tariffs on this process, the study used geospatial data from Ethiopian Roads Authority and Regional Roads AuthoritiesThe data series, which codes each segment according to surface type (dirt, gravel, or asphalt) and condition (new/rehabilitated or not), covers the period 1996–2010 and is complemented by average speed matrices published by ERA. In addition, data on public costs and investments, official RSDP reports, and territorial connectivity statistics were used. Throughout the series, significant inter-regional heterogeneity was observed: some areas reached road densities exceeding 50 km per thousand km², while others remained below 20 km, reflecting disparities in the pace of implementation.
To assess import costs, an indicator of tariffs on intermediate inputs was created. This indicator was calculated as a weighted average of the rates applied to imported materials and parts. The weighting followed official trade codes. This index was then cross-referenced with a panel of manufacturing firms. The panel gathers annual data on production, employment, use of domestic and imported inputs, as well as information on fixed capital and geographic location.
The TFP variable was measured annually for each firm in the industrial panel between 1996 and 2010. It corresponds to the residual obtained by relating deflated physical output to capital, labor, and intermediate material inputs. This residual reflects the overall efficiency of the firm, incorporating gains from technology, management practices, input quality, and economies of scale not captured by the observed inputs. To ensure comparability between firms and over time, TFP was standardized to have a mean of zero and a standard deviation of one within each year.
- Method
The basic specification involves a model in a two-dimensional fixed effects panel (Two-way fixed effects – (TW-FE) to estimate the impact of tariffs on TFP. The model controlled for the invariant heterogeneity of firms and the district-year combination to capture local temporal shocks. As control variables, firm age is incorporated, dummies export and foreign ownership. All models considered robust standard errors clustered at the sector-district level.
In the main analysis models, different specifications were used considering road accessibility and travel time to Galafi, a strategic crossing point between Ethiopia and Djibouti. In addition to the specification that considers only the interactions between the effective input tariff and the firms' covariates, we also estimated models that include: (i) road accessibility indicators and the logarithm of travel time to Galafi; and (ii) the interactions of these tariffs with each of these indicators and the indicators themselves. Besides firm-year and district-year fixed effects, industry-year and industry-district fixed effects were included to capture sectoral and regional shocks in different years.
The study also investigated the mechanisms and transmission channels of the impact of tariff liberalization, considering as dependent variables (i) the unit prices of imported inputs, (ii) the fraction of non-operational workers, (iii) the degree of capitalization (capital/labor), (iv) the adoption of new imported inputs, and (v) the probability of facing greater competition. To estimate the impact on outcome variables (i) to (iii), TW-FE models with different specifications were used, while estimates on outcome variables (iv) and (v) considered logit models.
Finally, methodological extensions included analyses of subsamples of firms entering, surviving, and exiting the market during the considered sample. For this, the same regression structure as the basic model was used. In addition, alternative performance variables were tested: revenue-based productivity (RFBP), applied to the national deflator, and... markup, obtained from the elasticity of intermediate inputs and their share of the total cost. All specifications added the interactions between tariffs, road accessibility, and travel time.
- Main results
The results of the main analysis revealed that a one percentage point (pp) increase in the effective input tariff reduced the average productivity of firms by 0,25%, while the operating profit margin decreased by 0,15%. Production volume fell by 0,3% for each 1 pp increase in the tariff, indicating an immediate impact on productive capacity. These effects remained statistically significant even after adjusting for macroeconomic variables and sectoral characteristics. The reduction in technical efficiency was particularly pronounced in industries with greater dependence on imported inputs, where the productivity elasticity reached -0,4%. Additionally, the tariff shock showed greater intensity in the initial years of the analyzed period, indicating a gradual adaptation of firms to the new trade barriers.
Heterogeneity analysis revealed that smaller firms suffered a more severe tariff impact: small companies exhibited a 0,35% decrease in productivity for each tariff point, compared to 0,18% for large firms. Technology-intensive sectors showed an average elasticity of -0,3%, while sectors with lower technological content registered -0,2%. The degree of capitalization moderated sensitivity to input costs: firms with a higher capital/labor ratio dampened up to 40% of the negative effect. Additionally, companies with a history of prior exports showed less pronounced responses, suggesting that international experience conferred greater resilience to tariff shocks.
The investigation of logistics channels revealed that infrastructure conditions managed to mitigate some of the additional costs. Firms located on fully paved routes reduced the sensitivity of tariffs by 0,1 percentage point in productivity elasticity, while routes with partial or non-existent paving amplified the negative effect by up to 0,05 percentage points. Each 10% increase in travel time to Galafi resulted in a 3% increase in the tariff impact on unit costs. The interaction between tariffs and road accessibility indicators reinforced that physical barriers acted as multipliers of the shocks, especially for companies with commutes exceeding four hours.
In the analysis that considered the market participation behavior of firms, the subsamples of new entrants, survivors, and exited firms showed distinct responses. New companies showed an average productivity drop 1,3 times greater than the overall sample, while established firms cushioned the shocks by 25%. Firms that left the market exhibited a more abrupt increase in costs before exiting, suggesting a link between tariff shocks and divestment decisions. The inclusion of interactions between tariffs and infrastructure confirmed that travel time had a more pronounced effect among entrants, reinforcing the role of logistical barriers in the dynamics of entry and exit.
- Lessons in Public Policy
This article evaluated the effects of tariff liberalization combined with improvements in transport infrastructure in Ethiopia observed since the 90s. The results showed that tariff reductions coupled with advancements in highways and port terminals increased trade volume and decreased logistics costs. Additionally, this policy synergy was found to have strengthened the integration of regional markets, regardless of the characteristics of the sectors analyzed.
The evidence from this study indicates that coordinating tariff adjustments and infrastructure investments can broaden both access to local markets and export competitiveness, providing policymakers with insights for designing economic interventions. The simultaneous adoption of these measures can guide future development strategies, reinforcing the importance of integrated policies to stimulate economic growth, especially for developing countries.
References
BLOOM, Nicholas; DRACA, Mirko; VAN REENEN, John. Trade Induced Technical Change? The Impact of Chinese Imports on Innovation, IT and Productivity. The Review of Economic Studies, v. 83, no. 1, p. 87–117, Jan. 2016.
FIORINI, Matteo; SANFILIPPO, Marco; SUNDARAM, Asha. Trade liberalization, roads and firm productivity. Journal of Development Economics, v. 153, p. 102712, nov. 2021.
TOPALOVA, Petia; KHANDELWAL, Amit. Trade Liberalization and Firm Productivity: The Case of India. Review of Economics and Statistics, v. 93, no. 3, p. 995–1009, Aug. 2011.
