TRADE POLICY AND MARKET POWER: FIRM‐LEVEL EVIDENCE

• Author: Olivier Cadot,Alan Asprilla,Nicolas Berman,Mélise Jaud
• Published date: 01 November 2019
• Date: 01 November 2019
• DOI: http://doi.org/10.1111/iere.12409

INTERNATIONAL ECONOMIC REVIEW

Vol. 60, No. 4, November 2019 DOI: 10.1111/iere.12409

TRADE POLICY AND MARKET POWER: FIRM-LEVEL EVIDENCE∗

BYALAN ASPRILLA,NICOLAS BERMAN,OLIVIER CADOT,AND M´

ELISE JAUD1

University of Lausanne, Switzerland; Aix-Marseille University, CNRS,EHESS, Centrale

Marseille, AMSE, France, CEPR, UK; University of Lausanne, Switzerland, CEPR, U.K.,and

FERDI, France; World Bank, U.S.A.

This article identifies the effect of trade policy on market power through new data and a new identification

strategy. We identify market power by observing how exporting firms price discriminate across markets following

variations in bilateral exchange rates. Pricing-to-market is prevalent in all countries in our sample, even among

small firms, although it is increasing in firm size. More importantly, we find that the effect of nontariff measures

(NTMs) is not isomorphic to that of tariffs. Whereas tariffs reduce the market power of foreign firms through

rent-shifting effects, NTMs reinforce the market power of nonexiting firms, domestic and foreign alike.

1. INTRODUCTION

Although the argument that trade policy affects competition is an old one (see, e.g., de

Melo and Urata, 1986), there is to date little systematic evidence on how trade policy affects

market power at the level of the firm and, in particular, how the effects of different trade policy

instruments play out. In a heterogeneous firms setting, nontariff measures (NTMs)—a widely

used class of trade policy instruments including, for example, technical or sanitary regulations—

affect market structure in ways that are not isomorphic to tariffs. Instead of merely shifting rents

from foreign to domestic firms, they also change market structure by affecting firms differently

depending on their size. For instance, a regulation may inadvertently create barriers to entry

that generate a dominant position. Evidence of such effects of tariffs and NTMs is scarce,

however, because assessing the market power of firms and how it relates to trade policy requires

estimating indicators such as price–cost margins or market shares in well-identified markets.

Both the identification of these measures and the definition of a market (and its structure) are

problematic, which is why research has so far limited itself to specific sectors, countries, and

trade policy instruments.

∗Manuscript received February 2017; revised July 2018.

1Olivier Cadot passed away in March 2019. Olivier was a profoundly kind and thoughtful friend and a remarkable

researcher. Working with him has been a privilege and an incredibly joyful adventure. We are grateful to George

Alessandria, three referees, as well Paulo Bastos, Richard Newfarmer, Frederic Robert-Nicoud, and to seminar partic-

ipants at CERDI, Nice Sophia-Antipolis, the Central Bank of Uganda, the World Bank, the ERF Annual Conference,

the ETSG conference, and the University of Lausanne for useful comments and suggestions. Special thanks to Caroline

Freund for detailed advice. Jingjing Xia provided excellent research assistance. An early version of this article was

prepared as a background paper for the World Bank’s “Champions Wanted” regional study and draws on prior re-

search undertaken with support from the International Growth Center. Support from France’s Agence Nationale de la

Recherche under “Investissement d’Avenir” grant ANR-10-LABX-14-01 and from Switzerland’s NCCR under WP6,

as well as from the governments of Norway, Sweden, and the United Kingdom through the Multi-Donor Trust Fund

for Trade and Development are gratefully acknowledged. M´

elise Jaud appreciates financial support from the Swiss

National Science Foundation. The project leading to this publication has received funding from Excellence Initiative

of Aix-Marseille University—A*MIDEX, a French “Investissements d’Avenir” programme and from the French Na-

tional Research Agency Grant ANR-17-EURE-0020. The opinions expressed in this study are those of the authors and

do not necessarily represent the views of the World Bank, its Board of Directors, or the governments that it represents.

Please address correspondence to: M´

elise Jaud, World Bank Group, 1818 H Street NW, Washington, DC 20433, U.S.A.

Phone: 202-247-8704. E-mail: mjaud@worldbank.org.

1647

C

(2019) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social

and Economic Research Association

1648 ASPRILLA ET AL.

This article follows a different route and identifies market power and how it is affected by

trade policy using insights from the pricing-to-market (PTM) literature. We rely on a growing

literature that establishes, theoretically and empirically, that the extent of firm-level PTM relates

to firm size, efficiency, and, ultimately, market power.2PTM implies that a firm faced with a

cost shock will adjust its price differentially across destination markets, depending on the price

elasticity of demand it perceives on each of them, which in turn depends on its market power.

However, neither cost shocks nor market shares are observed directly at the firm level.3Our

identification strategy goes around this by relating firm-level export prices (on which we have

data) to bilateral exchange rate shocks.

Consider a firm faced with a series of bilateral exchange rate shocks, one on each of its

destination markets. If it passed through the entirety of each shock onto consumer prices,

its producer price in the home currency would remain the same irrespective of destinations;

there would be no PTM. However, with incomplete pass-through, a fraction of each shock is

absorbed by the firm into its producer price; as a result, the uniqueness of the producer price

breaks down, giving rise instead to a series of differentiated ones by destination. In other words,

the firm prices to market. Like in the case of a symmetric cost shock, the reaction of a firm’s

producer price to an exchange rate shock tells us something about the elasticity of demand it

perceives on its destination market—that is, about its unobserved market power. Specifically,

a firm with strong market power in a given destination (hence a low perceived price elasticity

of demand) will absorb a large fraction of the bilateral exchange rate shock and conversely. As

destination markets vary in terms of their trade policy, we can then infer the effect of trade

policy on market structure by observing the pricing behavior of firms exporting there without

directly needing to observe their market shares or any other measure of market power.

We start by discussing the impact of trade policy instruments on PTM in the destination coun-

try using a class of heterogenous firms models featuring variable and endogenous markups. We

derive two main testable predictions, respectively, related to NTMs and to tariffs. Specifically,

we show that NTMs applied in a nondiscriminatory fashion—that is, in compliance with the

WTO’s “national treatment” clause, whereby imported and domestically produced products

must be treated alike—raise market power and PTM for incumbents if they induce the exit

of smaller firms, for example, through higher fixed costs.4Import tariffs, on the other hand,

decrease the sales of incumbents but also induce the exit of small firms, leading to an ambiguous

impact on market power. However, given their discriminatory nature, tariffs are more likely

to displace foreign firms in favor of domestic ones, implying that the intensive margin effect

dominates and in net tariffs reduce the market shares of exporters and thus their incentive to

engage in PTM.5

We then test these predictions using a large multicountry firm-level data set obtained from

customs administrations in 12 developing countries, ranging from low income to middle income.

We combine the firm-level data with destination product specific data on bilateral applied

tariffs as well as NTMs. The latter covers a wide range of measures ranging from sanitary and

phytosanitary measures to technical barriers to trade. Pooling together firm-level data from

several developing countries allows us to provide evidence on the extent of exchange rate pass-

through for countries and regions that have received little attention so far. It also allows us

to explore more systematically the impact of trade policy on competition and market power

using a sample of countries facing different trade policy arrangements, in particular preferential

tariffs. Importantly, the high dimensionality of the data enables us to account for unobserved

2See, for example, Krugman (1986), Feenstra et al. (1996), Atkeson and Burstein (2008), Berman et al. (2012), Auer

and Schoenle (2016), or Amiti et al. (2014).

3Market shares are not even observed at the more aggregated product level, as domestic firm sales are typically

not observed.

4We will leave aside the case of quantitative restrictions, as those have largely been phased out, and focus on

regulations, either sanitary or technical, of which there is a plethora in high- and middle-income countries.

5In the online appendix, we also provide a detailed discussion of these predictions using a specific model from

Atkeson and Burstein (2008).