DP17536 Globalization and Market Power
Economic theory suggests that the markup is a key 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. Trade-induced increases in competition leads to more concentrated markets via entry and exit, putting upward pressure on markups. Market shares reallocation toward larger, more powerful firms, increase the aggregate markup. We use a large episode of trade liberalisation in Spain to test this rich set of transmission mechanisms linking trade and markups. The overall effect of reductions in Spanish import tariffs 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 with high intangible investment experience a weaker reduction in markups. Supporting the theoretical insight that the feedback effect via concentration is stronger with higher barriers to entry. Increases in markups are also produced by reallocations effects but the results are weaker, suggesting that the link between trade and markups is mostly driven by changes at the intensive margin.