Rationalization effects of tariff reductions

We analyze a panel of 230 Canadian manufacturing industries to investigate whether trade Liberalization promotes efficiency through increased scale. During the six years following the Free Trade Agreement with the United States, Canadian manufacturing exhibited substantial rationalization - a decline in the number of plants accompanied by increases in output per plant. We find that the bilateral tariff reductions had opposing effects on scale. Contraction induced by lower Canadian tariffs largely offset the 10% scale increase caused by U.S, tariff cuts. The observed increase in scale arose due to currency depreciation, compositional shifts towards high-scale industries, and undercounting of small establishments. (C) 1999 Elsevier Science B.V. All rights reserved.