Trade liberalization and markups: Micro evidence from China

This paper presents evidence from highly disaggregated Chinese firm-product data that, given productivity, input tariff reductions induce an incumbent importer exporter to increase product markups. We further investigate empirically the mechanisms underlying this trade liberalization effect, and find that input tariff reductions decrease marginal costs, and their effects on markup adjustments are more profound among firms with higher import dependence. Moreover, we exploit unique features of Chinese data by comparing results for two trade regimes: ordinary trade (wherein firms pay import tariffs to import) and processing trade (wherein firms are not subject to import tariffs). While the aforementioned trade liberalization effects and mechanisms only apply to ordinary trade, processing trade samples are used in a placebo test. The paper also shows that more productive firms charge higher markups for products. All these findings are robust to alternative markup measures including one estimate using physical-quantity output data, different production function specifications, a subsample consisting only of pure exporters, and estimations based on our theoretical derivations. Institute of World Economy, School of Economics, Fudan University, Shanghai, China; School of International Business Administration, Shanghai University of Finance and Economics, Shanghai, China; Department of Economics and Faculty Associate of the Institute for Emerging Market Studies (IEMS), Hong Kong University of Science and Technology, Clear Water Bay, Hong Kong SAR-PRC, China; Faculty of Business and Law, De Montfort University, Leicester, United Kingdom. (C) 2017 Association for Comparative Economic Studies. Published by Elsevier Inc. All rights reserved.