Input-Trade Liberalization and Markups

This paper presents theory and evidence from Chinese firm-product data that, given productivity, trade liberalization via input tariff reductions induces an incumbent importer/exporter to increase product markups. This finding calls for a reconsideration of the well-established imports-as-market-discipline hypothesis, which states that a higher volume of imports intensifies competition and hence decreases the market power of a firm. This paper presents further empirical evidence to verify underlying mechanisms behind this finding: input tariff reductions decrease marginal costs, and tariff reduction effects on markup adjustments are more profound among firms of higher import dependence. Moreover, this paper exploits 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 effects of input-trade liberalization 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. These findings are robust to various estimation specifications and alternative markup measures