Foreign Demand, Competition Strategy, and Export Markups: Evidence from Chinese Multi‐Product Exporters

• Published date: 01 May 2022
• Author: Ming Xu,Tenglong Zhong,Qian Xie,Hongkui Liu
• Date: 01 May 2022
• DOI: http://doi.org/10.1111/cwe.12423

©2022 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 187–209, Vol. 30, No. 3, 2022 187

*Ming Xu, Associate Research Fellow, Institute of Industrial Economics, Chinese Academy of Social Sciences, China.

Email: xmphd@cass.org.cn; Tenglong Zhong (corresponding author), Associate Professor, School of International

Trade and Economics, Central University of Finance and Economics, China. Email: tenglong_zhong@126.com;

Qian Xie, Associate Research Fellow, Institute of Economics, Chinese Academy of Social Sciences, China. Email:

hbuxq@163.com; Hongkui Liu, Associate Research Fellow, Institute of Economics, Chinese Academy of Social

Sciences, China. Email: 450822729@qq.com. Tenglong Zhong is grateful for the support by the Youth Project from the

National Natural Science Foundation of China (No. 71903003), and the Program for Innovation Research in Central

University of Finance and Economics. Ming Xu is grateful for support from the Beijing–Tianjin–Hebei Coordinated

Development Think Tank Basic Research Project from the Chinese Academy of Social Sciences (No. 2020P05) and

the Major Project of Research and Interpretation of the Spirit of the 5th Plenary Session of the 19th Central Committee

of the Communist Party of China from the National Offi ce for Philosophy and Social Sciences (No. 21ZDA021).

Foreign Demand, Competition Strategy,

and Export Markups: Evidence from

Chinese Multi-Product Exporters

Ming Xu, Tenglong Zhong, Qian Xie, Hongkui Liu*

Abstract

Using Chinese microdata from 2000 to 2013, we document how demand shocks in export

markets lead multi-product exporters to adjust markups across products. We find that, in

response to positive demand shocks, quality-based competitive multi-product fi rms increase

product markups signifi cantly, particularly for core products, whereas cost-based competitive

multi-product fi rms respond by reducing product markups. The reason for this is that positive

foreign demand affects markups through two opposite channels: pro-innovative effects

and pro-competitive effects. Pro-innovative effects are predominant among quality-based

competitive multi-product fi rms, and these fi rms respond to positive foreign demand shocks

by increasing product quality, prices, and markups. Pro-competitive eff ects are predominant

among cost-based competitive multi-product fi rms, and these fi rms respond to positive foreign

demand shocks by lowering product cost, prices, and markups. We demonstrate the presence

of these mechanisms empirically. The results imply that firms with different competition

strategies should adopt diff erent measures in response to foreign demand shocks.

Keywords: competition strategy, export markups, foreign demand, multi-product exporters

JEL codes: F12, F14, L11, O14

I. Introduction

The literature on international trade mainly explores how firms respond to import

competition and finds that intensified import competition decreases product markups

Ming Xu et al. / 187–209, Vol. 30, No. 3, 2022

©2022 Institute of World Economics and Politics, Chinese Academy of Social Sciences

188

by domestic firms (Krugman, 1979; Feenstra, 2010; De Loecker et al., 2016). Few

studies examine empirically how firms respond to export competition induced by a

change in demand conditions in export markets. Mayer et al. (2020) are among the

few researchers to explore how multi-product fi rms reallocate their mix of products in

response to demand shocks in export markets. Mayer et al. (2020) assume that consumer

preferences follow Marshall’s Second Law of Demand, according to which the price

elasticity of demand decreases with the quantity consumed. Their model then predicts

a pro-competitive eff ect of trade, namely a reduction in markups in response to trade

integration. However, this markup response depends on the underlying parametric

assumptions imposed on consumer demand and the nature of competition. We therefore

aim to understand how trade integration (in terms of export market size) aff ects markups

without having to rely on explicit parametric assumptions about demand systems and

market structures. This study, therefore, contributes to the literature on trade gains. It

also provides suggestions about how Chinese fi rms should respond to foreign demand

shocks. This is especially important given the current uncertainties in the global markets.

The demand conditions faced by a fi rm in its export market can aff ect markups through

two contrasting channels. On the one hand, an increase in market size may drive fi rms to

innovate to upgrade product quality by increasing innovation rents (Aghion et al., 2018;

Lim et al., 2018). The price elasticity of demand decreases as product quality increases

(Kugler and Verhoogen, 2012; Antoniades, 2015), and product markups are inversely

correlated with price elasticity. As a result, foreign demand expansion may increase

markups through fi rm innovation to upgrade product quality. We refer to this channel

as “pro-innovative eff ects.” On the other hand, an increase in market size may induce

more fi rms to enter the market, increasing competition and reducing market share. The

price elasticity of demand then rises as the consumption falls (Mayer et al., 2014, 2020),

and markups are inversely correlated with price elasticity. As a result, foreign demand

expansion may decrease product markups by intensifying competition. We refer to this

channel as “pro-competitive eff ects.”

The overall eff ect of foreign demand on markups depends on the relative infl uence

of pro-innovative eff ects and pro-competitive eff ects. If pro-innovative eff ects outweigh

pro-competitive effects, there is a positive markup response to foreign demand. If

pro-competitive effects outweigh pro-innovative effects, there is a negative markup

response to foreign demand. If pro-competitive eff ects and pro-innovative eff ects have

an equal infl uence, there is an insignifi cant markup response. In this study, we examine

empirically the eff ects of these two channels using Chinese fi rm-level data.

Eckel et al. (2015) classify multi-product firms into two groups according to

whether a fi rm invests in upgrading the quality of its core products. Firms that invest in