Market power in distribution and pass‐through for consumers and producers

• Author: Miriam Manchin,Joseph Francois
• DOI: http://doi.org/10.1111/roie.12376
• Published date: 01 February 2019
• Date: 01 February 2019

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© 2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/roie Rev Int Econ. 2019;27:290–312.

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INTRODUCTION

Since the mid‐1990s, the combination of multilateral and bilateral trade agreements has led to a

steady reduction in European barriers to external trade. Since increased openness is widely believed

to increase competitiveness, the expectation has been that the resulting drop in prices at the border

would lead to both gains for consumers and increased competitive pressure on European industry.

In this paper, we examine the extent to which changes in landed import prices have actually reached

European consumers, and the extent to which European producers have faced increased pressure

linked to pricing.

While we are interested in the consumer and producer impact of changes in landed import

prices, the question is closely related to that emphasized in the exchange rate pass‐through liter-

ature. The focus of this literature has been on pass‐through from exchange rate changes to import

prices (Campa & Goldberg, 2005; Campa, Goldberg, & Gonzalez‐Minguez, 2005; Feinberg, 2008;

Gaulier, Lahrche‐Revil, & Mejean, 2008), domestic producer prices (Feinberg, 1989, 1996; Feinberg

Received: 23 January 2017

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Revised: 12 April 2018

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Accepted: 17 July 2018

DOI: 10.1111/roie.12376

ORIGINAL ARTICLE

Market power in distribution and pass‐through for

consumers and producers

Joseph Francois1

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Miriam Manchin2

1Department of Economics, University of

Bern, Bern, Switzerland

2School of Slavonic and East European

Studies, University College London, London,

United Kingdom

Correspondence

M. Manchin, School of Slavonic and East

European Studies, University College London,

Gower Street, London WC1E 6BT, United

Kingdom.

Email: m.manchin@ucl.ac.uk

Abstract

We examine the differential pass‐through of import prices

into consumer and producer prices. We develop a frame-

work with distribution costs and distribution market

power. We then examine pass‐through from import prices

to consumer and producer prices in the euro area using the

U.S. import price as instrument. We find that pass‐through

rates to producer prices are more sensitive to changes in

distribution margins than pass‐through to consumer prices.

Furthermore, only a portion of import price changes trans-

late into domestic price changes limiting potential con-

sumer benefits from tariff liberalization, with market

power in distribution services being one important factor

reducing pass‐through.

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Francois and Manchin

& Kaplan, 1992), and consumer prices (Campa & Goldberg, 2006; Frankel, Parsley, & Wei, 2012;

Hellerstein, 2008; Ihrig, Marazzi, & Rothenberg, 2006; Mishkin, 2008). These studies find ample

evidence that pass‐through is far from complete, with a substantial heterogeneity in the magnitude

of pass‐through when looking across both industries and countries (Gaulier et al., 2008; Goldberg

& Campa, 2010).

The literature points to a range of explanations for the incomplete consumer price linkage to ex-

change rate changes. For import prices, the underlying reasons range from local currency pricing

(Bacchetta & Van Wincoop, 2003), pricing strategies of the exporting firms (Amiti, Itskhoki, &

Konings, 2014; Berman, Martin, & Mayer, 2012; Burstein & Gopinath, 2014; Campa & Goldberg,

2005, 2006; Gopinath, Itskhoki, & Rigobon, 2010; Goldberg & Knetter, 1997; Gopinath & Rigobon,

2008), trade costs (Fitzgerald, 2008) and frequency of price adjustments (Gopinath & Itskhoki, 2010),

to differences in market structure of domestic firms (Auer & Schoenle, 2016).1

For consumer prices, the literature highlights costs added in the distribution and retail sector. For

example, both Burstein, Neves, and Rebelo (2003) and Berger, Faust, Rogers, and Steverson (2012)

find the distribution wedge (and distribution costs) to be significant (the latter paper finding the distri-

bution wedge to be around 50 to 70%). Goldberg and Campa (2010) also find that distribution margins

can dampen border price pass‐through into consumption prices. Auer, Burstein, and Lein (2017) uses

retail prices on individual consumer goods and find that the gap between border prices and consumer

prices account for a significant part of incomplete exchange rate pass‐through at the consumer level

in the Swiss case. In addition, some papers find that retailer market structure can have a significant

impact on the pass‐through rate (see, e.g., Antoniades & Zaniboni, 2016 for the case of exchange rate

pass‐through, Hong and Li (2017) for retail cost pass‐through).2

Another strand of literature that is also related to this study focuses on the changes in the conditions

for domestic producers and resulting effects on margins and producer prices induced by increased

trade openness. Here, trade openness is being measured as import penetration. Feinberg (1986) shows

that increased market concentration led to reduced pass‐through to industrial prices while increased

import penetration led to an increase in exchange rate pass‐through in Germany (see also Feinberg,

1989). Auer and Fischer (2010) look at the effect of low‐wage imports on U.S. producer prices while

Chen, Imbs, and Scott (2010) examine how increased openness affects producer prices and mark‐ups

in the European Union. In accordance with the exchange rate literature, these studies find that in-

creased trade affects producer prices substantively.3

In this paper, we examine the differential impact of changes in landed import prices on consumer

and producer prices in the euro area. One of our main contributions relative to the existing literature

is that we examine the impact on both consumer and producer prices in a unified framework that in-

volves joint treatment of market power for distribution firms vis‐à‐vis consumers and market power

vis‐à‐vis suppliers. In order to examine consumer and producer pass‐through in a unified framework

empirically, we concentrate on final goods. In addition, we also control for transmission of trade pol-

icy changes rather than just exchange rate changes.4 Furthermore, we examine joint pass‐through in

a sample based on the euro area countries which allows us to examine border price transmission in

a common currency setting where, in contrast to the United States, we have relatively wide variation

across E.U. Member States linked to differences in regulatory and retail structures.

To formalize the link between internal producer and consumer price transmission, we first ana-

lytically decompose factors driving price changes (distribution costs and distribution sector market

power) that are expected to contribute to variations in pass‐through. Differences between consumer

and producer price pass‐through are partly determined by market power in the trade and distribution

sector. We allow market power to vary in our model—this is in line with some more recent papers (see

e.g., Cavallo, Neiman, & Rigobon, 2014).