Prices, Markups, and Trade Reform

Abstract

This paper examines how prices, markups and marginal costs respond to trade liberalizaƟon. We develop a framework to esƟmate markups from producƟon data with mulƟ-product firms. This approach does not require assumpƟons on the market structure or demand curves faced by firms, nor assumpƟons on how firms allocate their inputs across products. We exploit quanƟty and price informaƟon to disentangle markups from quanƟty-based producƟvity, and then compute marginal costs by dividing observed prices by the esƟmated markups. We use India’s trade liberalizaƟon episode to examine how firms adjust these performance measures. Not surprisingly, we find that trade liberalizaƟon lowers factory-gate prices and that output tariff declines have the expected pro-compeƟƟve effects. However, the price declines are small relaƟve to the declines in marginal costs, which fall predominantly because of the input tariff liberalizaƟon. The reason is that firms offset their reducƟons in marginal costs by raising markups. Our results demonstrate substanƟal heterogeneity and variability in markups across firms and Ɵme and suggest that producers benefited relaƟve to consumers, at least immediately aŌer the reforms. Long-term gains to consumers may be higher to the extent that higher firm profits lead to new product introducƟons and growth. Indeed, firms with larger increases in markups had a higher propensity to introduce new products during this period.