1

CHAPTER 1:PRO-COMPETITVE EFFECT OF TRADE

1A: Imports as market discipline

1B: Empirical evidence

1C: Heterogeneity of firms, productivity,

mark-ups

Paper analysis: Bernard, Jensen & Schott (2006)

Globalisation and labour markets, H. Boulhol

2

1A: What drives specialisation?

• Classical trade theory

comparative advantage arises from:

- differences in technology

- differences in factor endowments

under constant returns to scale and perfect competition

• New trade theory

Increasing returns to scale enable to benefit from size/scale effects under imperfect competition

3

1A: Increasing returns to scale

• i.r.s. rule out perfect competition• problem: imperfect competition can be

formalised in many ways• strategic behaviours of firms shape market

structure• new mechanisms:i) size effects / increase in number of varietiesii) pro-competitve effects: decrease in mark-

upsiii) costs of transporting goods

4

1A: Mark-ups, Price-cost marginsFixed cost, oligopolistic behaviour

cost marginalprice

cost marginal

priceupmark is:

i) a measure of the intensity of competition ii) a measure of the size of product market rents iii) a key parameter for the conduct of monetary and competition policies

how to measure mark-up? how to measure marginal cost? Problem: measure of capital stock, user cost, speed of adjustment of the capital stock See Boulhol (2008 a) for a discussion about common methods to estimate mark-ups Convenient “simplistic” measure: price-cost margins

sales

profitscosts capital

sales

tesintermedia-wages-salesPCM

1A: Mark-ups, Price-cost margins

Under c.r.s. and no fixity of capital

24.020.0

04.025.1:

)/11(

PCM

sexample

salestotal in costs capital of sharesales

costs capitals

sPCM

index Lerner1/-1 Sales

Profits rate Profit

K

K

K

6

1A: Mark-up and Elasticity of perceived demand

)((.)max iiiy

ycypi

f.o.c.: 'iii

i

i cpyy

p

'1 ii

i

i

ii c

p

y

y

pp

At equilibrium, demand = output, i.e. ii yd

and i

i

iii

i

i

ii y

p

ypd

p

p

d

/

1

i is the elasticity of the demand perceived by firm i (>1)

'11 i

ii cp

Mark-up = i

iii cp

/11

1/ '

1lim,

ii

1A: Imperfect competition and inefficient allocation

7

Two goods X: perfect competition, c.r.s. Y: imperfect competition, i.r.s.

'XX cp '

YY cp

Y

X

Y

X

Y

X

p

p

p

p

c

cMRT

'

'

Good Y is too expensive, which drives too many resources in sector X

1A: Trade intensifies competition

• Gains from trade can arise from dissipation of rents

• “Oldest insight” in the area of trade policy under imperfect competition

• Imports increase competition by bringing prices closer to m.c. (reduced market power)

8

1A: Mechanism

• Increase in the elasticity of the demand perceived by firms facing import competition

• Effective entry of new (foreign) competitors displace low efficient (domestic) firms

• Domestic producers are likely to face a fall in their domestic market share

• Domestic concentration might increase,

while total concentration might decrease

9

1A: Pro-competitive effect of trade

10

Examples (see Boulhol, 2008b for generalisation) Aggregate demand: elasticity (CES) between different goods Substitution between varieties: elasticity (CES) Case 1: Monopolistic competition: each firms is able to differentiate its own product each firm is too small to influence other firms’ behaviour

i either in autarky or with trade

mark-up 1

i

Case 2: Homogenous good ( ) + Cournot competition with segmented markets Autarky: ii s/

Trade: )1(/ ii s where is the import penetration ratio,

11

1

i

i

s

ii

1A: Beneficial effect in terms of welfare

• Reduced market power• Relative marginal utility closer to relative marginal cost• Better allocation of resources across sectors

Beware: competition effect on welfare might not be monotonous: too intense competition might deter innovation

• Effect on aggregate productivity (Section 1C)• Effect on worker / manager effort

11

1A: Imports as product market discipline

12

Markusen et al. (1995) 2 identical countries: H, F X perfect competition Y homogenous good; a monopolist in each country, Cournot competition

YYsYYY HHFH /,

Cournot competition: 10

HH

F

Y

Y

Y

Y

'''

''

)/1()(

)()()(max

YYHYHYH

YY

HYHH

YYHYHFHYY

cspYcY

YYpp

YcYY

YppYcYYYp

H

Autarky: )/11('

'

YY

X

Y

X

p

p

c

cMRT

Openness: no trade but threat of trade: ))*2/(11( YY

X

p

pMRT

Example: 2Y Autarky: Y

X

p

pMRT 2/1 Openness:

Y

X

p

pMRT 4/3

The threat of trade reduces the distortion related to imperfect competition by one half

1A: Dumping

Hypothesis: 1) imperfect competition + fixed costs

2) segmented markets: domestic residents cannot easily purchase goods intended for exports

Price discrimination: imperfect competition implies that firms do not necessarily charge the same price for goods that are exported and those sold to domestic buyers

Each firm practices dumping in the foreign market as a result of total profit maximisation

13

1A: Dumping

• Dumping is the most common form of price discrimination in international trade:

a firm charges a lower price for exported goods

• Trade policy:

dumping is regarded as unfair (controversial)

special rules and penalties

14

1A: Intuition behind dumping

• imperfectly integrated markets

(transport costs, trade and cultural barriers)

• larger share in home than in foreign markets

• foreign sales are more affected by their pricing

• lower margin on exports

15

1A: Dumping can generate trade

• If firms are identical + homogenous good

then no dumping = no trade (because of transport costs)

But, incentive to limit the quantity sold domestically (to maintain higher price) + sell abroad at lower price (still above mc) = more profits

Intra-industry trade

Welfare? Reduced market power vs

wasteful to ship the same (or close substitute) good16

1A: Reciprocal dumping (B & K, 1983)

• Segmented markets, Cournot competition

(no interaction between firms under monopolistic comp.)

• good Z, price p , * means foreign

• constant marginal cost, c fixed costs, F

• iceberg transport cost, g < 1 : marginal cost of foreign sales = c/g

• x : output of the domestic firm sold at home

• y : output of the foreign firm sold at home

• x* : output of the domestic firm sold abroad

• y* : output of the domestic firm sold abroad

17

1A: Reciprocal dumping (B & K, 1983)

18

Z = x + y Z* = x* + y* F - ) g /* xx ( c - (Z*)* p* x ) Z( p x F - ) g /* y y ( c - (Z*)*p* y ) Z( py * FOC

0c/gp p'y

y

0cp p' xx

*

1A: Reciprocal dumping (B & K, 1983)

19

Notations: Share of the foreign firm in the domestic market : Zy / Demand elasticity: Z)' (p / -p FOC

))

(g( / cp

1)-( / cp

Intra-branch trade )1/(1/0 ggcp

2/12/10 p

1A: Reciprocal dumping (B & K, 1983)

Because of transport costs: 2/1 means a lower market share abroad

higher marginal revenue abroad ( gcxRcxR mm /*)(,)( * ) lower mark-up abroad dumping induces a decrease in prices

1A: Welfare effect of dumping

• Size effect (+)• Pro-competitive effect (+)• Transport costs (-)• Overall effect is ambiguous

• Result 1: trade is beneficial when transport costs are sufficiently low, and detrimental when high

• Result 2: with free entry, trade is beneficial unambiguously

21

22

Chapter 1: References

Mandatory readings in bold 1A Brander, J., Krugman, P., 1983. A ‘Reciprocal Dumping’ model of international trade,

Journal of International Economics, 15, 313-321. Boulhol, H., 2008a. The upward bias of markups estimated from the price-based

methodology, Annales d’économie et de statistique, Vol. 89. De Melo, J., Grether, Commerce international, Chapitre 7, De Boeck eds. Krugman, P.R., Obstfeld, M., 2008. International Economics, Chapter 6, Eighth edition,

Pearson eds. 1B Boulhol, H., 2007. The convergence of price-cost margins, Open Economies Review, 19(2),

221-240. Boulhol, H., 2008b. Pro-competitive effect of trade and non-decreasing price-cost

margins, Cahiers de la MSE. Pavcnik, N., 2002. Trade Liberalization, Exit, and Productivity Improvement: Evidence from

Chilean Plants. Review of Economic Studies, vol. 69, No 1, 245-276. Roberts, M.J., Tybout, J., 1996. Industrial Evolution in Developing Countries, Oxford UP. 1C Antras, P., 2006. Lecture notes. Bernard, A.B., Eaton, J., Jensen, J.B., Kortum, S., 2003. Plants and Productivity in

International Trade. American Economic Review 93 (4), 1268-1290. Bernard, A.B., Jensen, J.B., Schott, P.K., 2006. Falling Trade Costs, Firms, and

Productivity, Journal of Monetary Economics, 53, 917-937. Boone, J., 2000. Competition, CEPR Discussion Paper No 2636. Melitz, M.J., 2003. The Impact of Trade on Intra-Industry Reallocations and Aggregate

Industry Productivity, Econometrica, 71, 1695-1725. Melitz, M.J., Ottaviano, G.I.P., 2008. Market Size, Trade, and Productivity. Review of

Economic Studies, vol. 75, 295-316.