Trade Policy and Market Structure

Rating:
Summary: Review of "Trade Policy and Market Structure"
Review: The stated purpose of the authors in this book is to bring order to the variety of models that have appeared in the analysis of international trade policy in imperfectly competitive markets. Throughout the book they rely on partial equilibrium models. When there are cases in which general equilibrium effects alter conclusions, the authors point them out.

The three central issues that recur in this book are the effects of trade policy on market power, the strategic effect of trade policy on competition and the effect of trade policy on consumer choice.

The defining feature of imperfect competition is that firms do not take prices as given. As a result they do not regard the sole effect of selling another unit of output on their revenue as being the price of that unit; they have some conjecture about what effect selling more will have on the revenue they get from inframarginal sales. The end result is that price normally exceeds marginal cost.

The ratio of price to marginal cost is one measure of market power. A trade policy may alter the markup of price over marginal cost in ways that are benefitial or harmful to the country that initiates the policy.

This book shows that problems involving market power can be analyzed by focusing on perceived marginal revenue -- the increase in revenue that a firm expects to receive by producing one more unit, which is always less than the price (because of the effect on intramarginal sales) but may exceed the true marginal revenue that would prevail if the industry acted in concert.

An aspect of the new literature on trade policy under imperfect competition is the possibility that interventionist trade policies may have beneficial strategic effects. A strategic move is an action that is not profitable viewed in isolation but that alters the terms of subsequent competition to a firm's benefit. For instance, a firm may invest in excess capacity that it does nor intend to use, but whose presence deters potential competitors from entering the market. Government trade policies may serve the same kind of role.

Some questions that this book brings up in this regard are: How likely is it that a government will be able to have the information necessary to conduct a successful strategic policy? and Are there likely to be offsetting effects in the kind of industry to which the strategic trade argument might apply?

Making a commodity is costly, but if its price exceeds its marginal cost, then the resources used to produce it might not have an equally productive use elsewhere. In priciple, policies that induce consumers to purchase domestic goods whose price surpasses marginal cost may raise national income.

Protection can under some circumstances induce an increase in domestic production that actually lowers prices to consumers.

Arguments based on imperfect competition, external economies and factor market distortions have substantial empirical support and are the most powerful professionally respectable arguments against free trade.

In international trade policy analysis, distortions that could justify government intervention were superimposed on a theoretical structure whose logic was that of competitive equilibrium. In the new theory the imperfections are built into the structure from the get go.

The reasons for treating trade policy conclusions cautiously are: 1) Uncertainty, the effects of a given policy may depend crucially on the details of the market. 2) Domestic political economy, there are people eager to appropriate the result of new trade theories to support dubious causes. 3) International rivalry, a policy that benefits one country acting unilaterally may be harmful if everyone does it.

Since quantitative analyses seem to indicate that the gains from even optimal intervention are small, many economists have suggested that free trade remains a useful rule of thumb, even though it is rarely optimal in modern trade policies.

The book develops the arguments gradually, starting with market structures that exhibit one-sided market power and moving on to those that show two-sided market power. After providing background on trade policy in a competitive environment, the authors discuss import protection by a country with a domestic monopoly or oligopoly. Then they deal with import protection in an economy that faces a foreign monopoly or oligopoly, while domestic supply is nonexistant or competitive.

Later in the book strategic interactions come in to play beginning with an export-market scenario whereby domestic firms with monopoly power compete with foreign firms with monopoly power too. This is followed by an exploration of the role of strategic interactions in a domestic market in which domestic firms with market power compete with foreign firms with market power as well.

Trade policy in the presence of two-way trade, which may arise from monopolistic competition in differentiated products or for strategic reasons, is also examined in this volume. Finally, the authors review the recent literature that tries to quantify the effects of trade policy in noncompetitive environments. The new methodology and the numerical results are discussed.

There are four main areas in the analysis of trade policy under imperfect competition that deserve further investigation: 1) Models of market structure that make size distribution of firms endogenous. 2) Models of cooperative behavior to reflect some real-world activities of oligopolists. 3) Models with real dynamics in which trade policy can change the long-run rate of growth. 4) Quantification to confront the models with data so as to narrow down the possibilities.

In its time, this was a ground-breaking book. Hopefully, since its publication in 1989, economic researchers around the world could have taken note of the fields where deeper work was needed and made significant progress in constructing better models. By now, there should be already something in print that sums up the gains in the past decade, so it would be advisable to try to look up these updated books too.

Rating:
Summary: should be required reading for trade policymakers everywhere
Review: This slim volume presents the normative theory of international trade under imperfect competition in a systematic manner. One cannot help but come away from it with a profound sense of caution about the advisablility of policies aimed at shifting rents. This ought to be required reading for all policymakers interested in "strategic trade theory." Unfortunately, it is not.