Import-competition, market power and productivity change

We explore how the competitive pressure of imports affects productivity, at the firm level. There are two conflicting effects of import-competition: the pro-competitive effect fosters productivity, while the direct effect hinders it. The pro-competitive effect dominates in the steady-state, yielding free-trade as the optimal long run policy. However, under a large initial productivity gap, the firm shuts down. Here, a temporary tariff sways the firm to fight, and ensures survival, which is welfare increasing. Trade liberalization, around the steady-state, increases productivity growth and closes the gap. However, a radical liberalization kills the domestic firm. Gradualism increases the likelihood of survival, and increases welfare.