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

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

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.

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

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

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)

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

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

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)

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

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

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