Trade liberalization, road expansion, and factor market distortion

Factor market distortions and resource misallocation are significant contributors to differences in productivity. In this paper, we examine the role played by road improvements in determining the impact of an input tariff reduction on factor market distortions. Using firm-level data from China’s manufacturing sector and employing a difference-in-difference approach following China’s WTO accession, we find a strong complementarity between road infrastructure and input tariff reduction in reducing firm’s factor market distortion. This result remains robust under various robustness checks. The further analysis reveals a more pronounced impact on foreign-invested enterprises, non-importers, and firms with scarce capital. Mechanically, better road access magnifies the pass-through effect of input tariff reductions, enhancing allocative efficiency brought by trade through improved market competition. This paper highlights the importance of transportation in ensuring a reduction in domestic firm distortions following trade liberalization.