Globalization and market power

Economic theory suggests that the markup is the most appropriate measure of market power and that its relationship with trade is rich and complex. Trade liberalisation can reduce markups via a decline in the residual domestic demand but also increase it via several channels. First, the incomplete pass-through of the cost reductions produced by lower input tariffs. Second, trade leads to more concentrated markets via entry and exit, putting upward pressure on markups. Third, market shares reallocation toward larger, more powerful firms, increase the aggregate markup. We propose a simple model of trade under oligopoly which incorporates all these channels. Using a large episode of trade liberalisation in Spain, we test this rich set of mechanisms linking trade and markups. The overall effects of trade on firm level and aggregate markups is pro-competitive but we find evidence of offsetting effects via the other channels. In particular, we show that firms protected by higher barriers to entry, measured as high intangible investment, R&D spending and patents, experience a weaker reduction in markups. Supporting a new theoretical insight emerging from our model that the feedback effect on trade-induced concentration on markups is stronger with higher barriers to entry.