Openness and Productivity: a Model of Firm-Owners' Effort, with an Illustration from Mexican Microenterprises

Working Paper Number: 
WP 17-06

This paper asks two questions. First, when countries open up, what are the incentives of firm owners to invest in the productivity of their firms? And why do they wait until the country opens up to do so? To explore these questions, I set up a simple model in which firm owners choose the optimal mix of profits and leisure. The key insight is that openness drives a wedge between "productive" and "unproductive" firm owners, driving up the price of leisure, and therefore the incentives to innovate. The model is modified to consider one further insight: when countries open up, the real price of a consumption basket goes down because consumers enjoy more variety, which again changes the relative price of leisure. I illustrate the model implications with a survey of small firm owners in Mexico.

JEL Codes: 
F10, F14, F63