Trade Policy and Market Power

A colleague, Bruce Blonigen, says we should pay more attention to the anti-trust implications of trade policy, something that is almost always ignored in trade policy discussions:

Market power and the (non-)application of competition laws to trade policies, by Bruce Blonigen, Vox EU: The main premise of antitrust (or competition) laws is to proscribe practices that allow firms to limit competition in the marketplace. As is well known, limiting competition allows firms to raise prices above their marginal costs (something we call market power). Market power creates profits for firms, but the profits are more than offset by losses in consumer surplus. This translates into net (or deadweight) losses for society, and such losses are, obviously, something to be avoided.

The problems associated with market power are generally well recognised by the public when the topic of discussion is domestic competition and anti-trust policies. However, when the topic is trade policy, public discussion of how it might affect market power is often confused or nonexistent. For example, one virtually never hears any worry about the potential anti-competitive effects from applying traditional forms of trade policies, such as import tariffs and quotas.

The only place that one finds competition policies mentioned with trade policies is with respect to antidumping laws. And here the application of these principles is one-sided. It is recognised (and likely overemphasised) that there can be anti-competitive effects when a foreign firm uses low prices to eliminate competitors; i.e., predatory pricing practices. However, it is clear that the actual implementation of antidumping laws applies remedies for a whole range of pricing behaviours that any competition agency would find perfectly consistent with a competitive marketplace (for example, see “Why we need antidumping reforms”).¹ Indeed, the danger of antidumping remedies is that they could actually promote anti-competitive effects by helping firms collude (actively or tacitly) to achieve joint monopoly/cartel prices and profits. Most directly, this can be seen in the case of “undertakings,” whereby government agencies coordinate arrangements with foreign firms (and in consultation with domestic firms) to keep the foreign firms’ prices at predictably high levels in lieu of antidumping duties! Even a quick scan of an introductory industrial organisation text would suggest to you that this could be quite an effective mechanism for firms to coordinate tacit collusion.

Trade policy and market power in theory…

Though largely ignored in public discussions of trade policy, economists have been reasonably good at showing theoretically how various trade policies may affect market power. In general, the theoretical literature finds large market power effects from quantitative restrictions and none with tariff-based import protection.² There is also a literature indicating that antidumping measures can raise firms’ market power for similar reasons as quantitative restrictions; namely, that such policies can allow firms to tacitly coordinate higher prices to their benefit, but to the detriment of consumers and overall welfare (for example, see Prusa 1992).

Why does the issue of market power rarely enter public discussion of trade policies? There are a number of possible explanations, but let’s discuss two where at least some of the responsibility can be placed on the economics profession. First, economists have simply not laid out these arguments very often. For example, the standard models used to illustrate trade policies in today’s typical undergraduate textbook assume perfect competition. In such a setting, import protection increases employment in the protected sector, as well as infra-marginal rents of producers, but does not lead to market power for firms by assumption. Economists need to do a better job in presenting the conceptual reasons for why trade protection programs can raise market power and lead to the same sort of welfare losses that arise in more familiar cases where monopoly power leads to undesirable outcomes.

The second explanation is that the economics profession has not provided any empirical evidence for these market power effects. These effects may exist in theory under the right sets of assumptions, but do these effects really occur?

… and in practice

Empirical evidence on this issue is beginning to emerge, and the results of a couple of recent studies suggest that we ignore the potential anti-competitive effects of trade policies at our peril. In a recent paper I co-authored with Benjamin Liebman and Wesley Wilson, we undertake a systematic investigation of the market power effects of the wide variety of trade protection programs afforded to the U.S. steel industry over the last three decades (Blonigen, Liebman, and Wilson, 2007). The U.S. steel industry has been the main industrial sector receiving trade protection during this time period, accounting for more than a third of all antidumping and countervailing duty cases, as well as enjoying periods with quantitative restrictions and safeguard remedies on imports. Our statistical results are strongly consistent with the theoretical literature described in footnote 1 in that we find large market power effects from quantitative restrictions and none with tariff-based import protection. In fact, our estimates cannot reject the hypothesis that the U.S. steel industry was able to perfectly collude during the main quota period in the late 1980s.

Surprisingly, our estimates find no market power effects from antidumping protection in the US steel industry, which the theoretical literature suggests could be significant. These results contrast with recent evidence from Jozef Konings and Hylke Vandenbussche (2005) that antidumping duties in the European Union did raise market power significantly for many domestic firms that received antidumping duties against their import rivals. However, Konings and Vandenbussche note that market power effects are much lower or even nonexistent for products where antidumping protection leads to significant import diversion – market share gets diverted to import sources not targeted by the antidumping protection, rather than the domestic firms. The is a likely explanation for our finding of little market power effects for U.S. steel antidumping cases, as Prusa (1997) found significant trade diversion in U.S. antidumping cases.

Conclusions

What does this all mean in light of trade policy developments over the past decade? There is both good news and bad news. The good news is that the Uruguay Round made substantial progress in eliminating quantitative restrictions, which theory and empirics suggest are by far the most harmful trade policies in terms of raising market power. The bad news is that antidumping measures are acceptable under WTO agreements and have proliferated across member countries substantially in the past decade. While the initial evidence on market power effects of antidumping measures is mixed, the theory is clear in suggesting many ways in which such protection can raise market power.

While there may be political reasons to keep trade measures such as antidumping in place, as a profession, economics needs to continue to bring more evidence to bear about the market power effects of these programs. At the same time, we need to also continue to press policymakers more about the need for competition laws to apply equally to domestic and foreign firms. If policymakers can see the logic of having national treatment laws with respect to things such as tax policies towards firms in a market, then perhaps they can also be engaged to think about national treatment with respect to application of competition laws. As it stands, antidumping policies are a completely different (and wrongheaded) set of competition laws applied only to foreign firms exporting to a market.

References

Bhagwati, Jagdish N. (1965). “On the Equivalence of Tariffs and Quotas,” in R.E. Baldwin et al., eds., Trade, Growth and the Balance of Payments: Essays in Honor of Gottfried Haberler, Amsterdam: North-Holland.

Blonigen, Bruce A., Benjamin H. Liebman, and Wesley W. Wilson (2007). “Trade Policy and Market Power: The Case of the US Steel Industry,” NBER Working Paper No. 13671.

Konings, Jozef, Hylke Vandenbussche, and Linda Springael (2001). “Import Diversion Under European Antidumping Policy,” Journal of Industry, Competition and Trade, Vol. 1(3): 283-299.

Konings, Jozef, and Hylke Vandenbussche (2005). “Antidumping Protection and Markups of Domestic Firms,” Journal of International Economics, Vol. 65(1): 151-65.

Krishna, Kala. (1989). “Trade Restrictions as Facilitating Practices,” Journal of International Economics. Vol. 26: 251-270.

Prusa, Thomas J. (1992). “Why Are So Many Antidumping Petitions Withdrawn?” Journal of International Economics. Vol. 33: 1-20.

Prusa, Thomas J. (1997). “The Trade Effects of US Antidumping Actions," in Robert C. Feenstra, ed., Effects of US Trade Protection and Promotion Policies, NBER Project Report Series. Chicago,IL: University of Chicago Press.

Footnotes

[1] Hylke Vandenbussche and Maurizio Zanardi, “Antidumping in the EU: the time of missed opportunities,” VoxEU, 8 February 2008.

[2] Perhaps the first formal treatment dates back to Bhagwati (1965), who showed that a binding quota would allow a domestic monopolist to continue to wield market power in the face of lower international prices, whereas a standard import tariff would drive the domestic monopolist price to the competitive international price (plus tariff). Game theoretic analysis of oligopoly games also indicate that quantitative restrictions on imports allowed firms to increase market power, while import tariffs do not change existing market power (for example, see Krishna 1989).

Comments

[don]

Nice post. But a question about market power and antidumping. If antidumping prevents foreign suppliers from developing market power, but gives domestic producers market power, what is the net effect on competition?

China is dumping big time, across a wide spectrum of commodities, and putting many U.S. industries out of business. Is there any need to worry?

[Dickeylee]

Oh, Don typed a funny! Any need to worry? About China? I nominate Don for the next Fed Governor opening, with his insight, we'll all sleep better at night. Chairman even!

[zinc]

The question is legitimate. Is opening the domestic market to foreign competition from communist, state owned companies or joint foreign government/industry enterprises, anti-competitive.

IMO, yes. In the case of Japan and China, the state owns a monopoly position in the producing sector as well as selecting their competitors.

[don]

Yes, Dickeylee, I was serious (and I hope you were, too). Remember Bastiat's "the Candlestick Makers' Petition?" Trade people are reluctant to put much credence in the notion that state-sponsored industrial policy leads the sponsor to anything but disaster. But for what it's worth, I agree with zinc.

But I still want to know, was the issue covered in Blonigen's research?

[Bruce Wilder]

I actually hear a lot of popular discussion of market power in critiques of "globalization". For lots of people, "globalization" is code for manipulating free trade to augment established market power. The view is increasingly widespread that "free trade" has been captured and manipulated by established oligopolists, with considerable market power, and used to augment that market power. Wal-Mart is a poster child for the ability of a firm with considerable gate-keeping and distributional rents to profit from massive imports. But, the same could be said for all kind of manufacturers, with established brands and distribution networks that commission their gadjet manufacturing in China -- everything from laptops to toy dolls -- screwing their unions, their domestic suppliers and the Chinese in the process.

[Jay]

"The main premise of antitrust (or competition) laws is to proscribe practices that allow firms to limit competition in the marketplace."

That is funny, because Carnegie's premise was that antitrust laws were there to protect his businesses from competition.

[Real Person from the Real World]

I am sure all the professional, and non-professional economists will argue with me, but doesn't importing labor (h1b visas) interfere with the labor market? We give jobs away, that pay well $40-$125+ per HOUR, for commodity IT jobs (java, oracle, SAP, .NET) and these guys get vetted by companies at home and over seas somewhere, then get the mid level experience here, and when they get that green card, suddenly, they are in line to run IT, while US grads are competing all along the line, and there are few entry level jobs and no subsidized education and health care here, as there is elsewhere. Meanwhile, while these guys face backlash from Americans, the small foreign vendors are the ones making most of the money, and forging under the table ties with their compatriots.

[Real Person from the Real World]

from another page in today's blog:
"Third and most fundamentally, growth in the global economy encourages the development of stateless elites whose allegiance is to global economic success and their own prosperity rather than the interests of the nation where they are headquartered"
THIS INTERFERS WITH LABOR AS WELL AS TRADE!

[hari]

The anti-dumping measures have been there under GATT/UNCTAD for decades (I got officially involved with international trade policy in 1970s). During The Uraguay Rounds it was not anti-dumping measures that was a constraint...but the real issue was one of *trade reciprocity* in negotiating rates of reduction in industrial tariffs. It moved slowly under GATT Rounds, but we achieved incremental reduction in gloabl tariffs across the board.

Under WTO, tariffs are basically not an issue...domestic protection/subsidy of agri-industrial sector in US/EU doesn't
facilitate progress on Doha Round. It won't, as far as I can note from the reaction from India, Brazil, South Africa and China. The emerging markets are now united and aware of anti-dumping measures, as codified and carried over, under WTO rules including mandatory arbitration. Under GATT rulings on trade distortions were advisory. The strategic perspective was essentially that you've to bring the emerging markets around the table and involve them in OECD type of detailed negotiations. Recall, in the post-war period and until end of 1960s, developing countries priorities and constraints were NOT the primary focus of GATT negotiations.