"Competition, Markups, and the Gains from International Trade" NSF Proposal
Chris Edmond, Virgiliu Midrigan, Daniel Xu
This project studies the pro-competitive effects of policies that eliminate barriers to international trade.
Most existing research focuses on gains from international trade that arise from increased specialization or from increased diversity in consumption. This project focuses on an alternative mechanism, namely the increase in the amount of competition domestic producers face when international trade barriers are reduced. Greater competition can lead, in theory, to a drop in markups (price-cost margins) and in markup differences across domestic producers, thereby leading to an increase in production, employment and efficiency and large potential welfare gains. This project aims to measure the strength of this mechanism by combining theory and firm-level data from a number of countries that have experienced trade liberalizations.
Measuring the response of markups to trade liberalizations is a difficult task since data on markups is generally unavailable. This project seeks to make progress on this dimension by combing recent theoretical models of markup determination with state-of-the-art estimation techniques from the field of industrial organization to carefully estimate producer-level costs and markups.
The project uses several sources of information to measure the response of markups to changes in trade barriers. One source of information the project exploits is the relationship between price-cost margins and the amount of competition individual producers face, as measured by a producer's market share in its own industry. To the extent to which price-cost margins vary a lot with the amount of competition, a decrease in trade barriers, by increasing competition, can have a significant effect on the average level of domestic markups. A second source of information the project exploits is the response of price-cost margins to individual episodes of trade liberalizations. By exploiting the differential impact of various trade agreements (such as NAFTA) on different industries' trade patterns and price-cost margins, the project can shed light on the effect individual episodes of trade liberalizations have had on the amount of competition and the level of markups in different industries in the US and other countries.
The project's findings have ramifications beyond international trade and will shed light on the role of markups for cross-country income differences and business cycle fluctuations. Cross-country differences in income reflect, in part, differences in the efficiency with which resources are allocated across producers. Differences in markups may be an important source of allocative inefficiency and the project will examine whether this is indeed the case. Markup fluctuations may also play an important role in explaining the large recent drop in US employment in the aftermath of the financial crisis and more generally around episodes of large contractions in economic activity. Such recessions are typically associated with large declines in labor's income share. Whether such declines are accounted for by an increase in producer markups, or inefficiencies in the labor market is an important question that the project will address by studying producer-level data during episodes of large recessions and financial crises.
