Imports and productivity

How do imports affect firm productivity? To answer this question, we estimate a structural model of importers using a panel of Hungarian firms. In our model with heterogenous goods, imported inputs improve productivity because (1) they are imperfect substitutes of domestic inputs; and (2) they have higher quality. This model yields a production function where output depends both on conventional factors and the number of product varieties imported.
We estimate this import-augmented production function with the Olley and Pakes (1996) procedure, and find that increasing the fraction of product varieties imported from 0 to 100 percent leads to a productivity gain of 14 percent. About two thirds of this gain can be attributed to imperfect substitution, while the remainder is due to the higher quality of imports. We also compute the effects of a hypothetical tariff cut, and find that for small
firms, it improves productivity through importing more product varieties, while for large firms it improves productivity through increasing existing imports.