Abstract
Trade in intermediate goods has become a significant feature of the international economy. Nevertheless, questions regarding price negotiation and the determinants of importing firms’ profitability remain unanswered. Using firm-level data, we attempt to address these issues in the context of the Chinese steel industry. Despite being the largest producer of steel in the world, the Chinese steel industry has maintained a very low level of profitability. This paper suggests that the low profitability of Chinese steel producers results from the abnormally high degree of market segmentation in China. Using a recently developed econometric method in panel data spatial analysis, we explain the level of geographic fragmentation in the Chinese steel industry. Our results reveal that local steel production depends only on local demand rather than on cross-regional demand. Production is responsive, as a 10% increase in local GDP induces more than 8% increase in local steel production, while the cross-province spill-over demand is insignificant under several reasonable model specifications. Less efficient firms survive because of the segmented market. As a result, Chinese steel producers realize lower profit in the face of high input prices.
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