Market Power and Trade Policy
Though policymakers show great concern for market power when discussing antitrust policy, they neglect it when designing trade policies. This column summarises recent empirical research showing that some trade barriers impose significant costs on consumers by substantially raising the market power of domestic firms.
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.
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.
Bruce Blonigen is the Knight Professor of Social Science, Department of Economics, University of Oregon.
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.
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).