On the Relationship between Tariff Levels and the Nature of Mergers

Abstract This paper employs an endogenous merger formation approach in a two-country oligopoly model of trade to examine the international linkages between the nature of mergers and tariff levels. Firms sell differentiated products and compete in a Bertrand fashion in product markets. Two effects play key roles in determining equilibrium market structure: the tariff saving effect and the protection gain effect. The balance between these two effects implies that, when foreign country practices free trade, low home tariffs yield international mergers irrespective of the substitutability levels. By contrast, when foreign tariffs are sufficiently high and products are close substitutes, national mergers obtain in the equilibrium. Unlike this asymmetric result of unilateral trade liberalization, we find that when bilateral tariffs are sufficiently low, international mergers arise. These results fit well with the fact that global trade liberalization has been accompanied by an increase in international merger activities. From a welfare perspective, we show that international mergers are preferable to national mergers and thus social and private merger incentives become aligned together as trade gets bilaterally liberalized. Finally, if countries can commit to a trade policy, they would optimally commit to a low tariff to induce international mergers when products are close substitutes while any tariff commitment is optimal when products are sufficiently differentiated.