CHAPTER 1: PRO-COMPETITVE EFFECT OF TRADE

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. 1C: Heterogeneity of firms • Intensity of competition and aggregated mark-ups when firms are heterogenous • Burgeoning literature on firms’ heterogeneity: reallocation of resources / activities across firms

3. 1C: Measures of increased competition • Theory: - Reduction in entry barriers (domestic, foreign) - More agressive interactions between firms (e.g. Bertrand vs Cournot) • Increase in the elasticity of substitution between goods • Empirics: - Industry concentration, bumber of firms, mark-up, PCMs, profit ratios, etc.

4. 1C: Problem • These theoretical and empirical measures are not necessarily consistent • Market structure is endogenous • Example:

5. 1C: Two main results (Boone, 2000) • Profits of the least efficient firm is reduced by increased competition (when firms are identical, all mark-ups / PCMs decrease) • Competition increases the profits and output of any firm relative to those of a less efficient one Darwinian metaphor Competition magnifies differences in efficiency by punishing the laggards more severely

6. 1C: Firms in trade theory (Antras, lecture notes) • Neo-classical trade theory: - Firms are treated as a blackbox - c.r.s. means that size of firm is indeterminate • New trade theory (DSK): - each industry variety is produced by a single firm in just one country … - … which exports everywhere else in the world (iceberg transport costs affect only m.c., foreign competition does not affect mark-ups)

7. 1C: Stylised facts • Exporters are a minority (20% of US plants) • Exporters sell most of their output domestically (2/3 of exporters sell less than 10% of their output abroad) • Larger firms tend to be more productive and have higher mark-ups

8. 1C: Stylised facts • Exporters are (5 times) bigger than non exporters • Exporters are on average 30% more productive (suggests that firm self-select into export markets) • After trade liberalisation episodes, substantial reallocation effects within industries: market share reallocation towards more productive firms, thereby increasing aggregate productivity

9. 1C: Implications for theory Theory should include: • Firm heterogeneity in size and productivity • A feature that leads only the most productive firms to engage in foreign trade (e.g. sunk cost of exporting)

10. 1C: Melitz (2003)

11. 1C: Melitz (2003)

12. 1C: Melitz (2003) • Aggregate productivity gains: • trade reallocates market shares from purely low efficient to high efficient firms, from domestic producers to exporters • most efficient firms gain the most from exposure to trade • Two opposite effects for surviving firms: - face increase in competition from importers - Benefit from the exit of less efficient domestic firms • The most efficient firms also expand in the foreign markets

13. 1C: What drives reallocation? • More efficient trade-induced reallocation across firms is a common feature of new firm heterogenity models, but channels differ: • in Melitz (2003, CES+monopolistic competition=no effect on mark-up), channel = increase in labour market competition: trade triggers increased competition for scarce labour resources as real wages are bid up by the more productive firms who expand to serve the export markets • in Melitz and Ottaviano (2005, mark-up depends on market share), channel = increase in product market competition: no labour market channel as supply of labour to the differentiated goods sector is perfectly elastic; however, least-efficient firms (low mark-up) are forced to exit

14. 1C: Pro-competitve effect of trade and heterogeneity of firms Three effects: • Direct pro-competitve effect: import competition tends to reduce market power of all firms (foreign firms that effectively enter the market are de facto more competitive than domestic firms that exit) • Reallocation effect: to the extent that most efficient firms have bigger mark-ups, reallocation tends to mitigate the first effect • Access to foreign markets? Total effect depends on the distribution of firms’ heterogeneity Example: in BEJK (2003) with Frechet distribution, aggregate mark-up is not affected by trade In this case (BEJK), as in Melitz, trade leads to a more efficient equilibrium generating productivity gains at constant mark-up