Input-Trade Liberalization and Markups

HKUST IEMS Working Papers No. 2015-26

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Haichao Fan, Yao Amber Li, Tuan Anh Luong

This paper presents theory and evidence from Chinese firm-product data that, given firm productivity, trade liberalization increases product markups. This finding calls for a reconsideration of the well-established imports-as-market-discipline hypothesis. This paper further verifies underlying mechanisms behind this finding: input tariff reductions decrease marginal costs, and tariff effects on markup adjustments are more profound among firms of higher import dependence. 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), this paper finds that the aforementioned effects only apply to ordinary trade.

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