The Impact of WTO Accession on Chinese Firms’ Product and Labor Market Power

Abstract

This paper examines the causal impact of domestic trade liberalization on Chinese firms' product and labor market power. To recover both market power measures, we identify a firm's regime of competitiveness, corresponding to a product market setting and a labor market setting, at any point in time. The identification is based on implementing the distance test, which takes the dependence between both settings into account. The product market setting is defined to be imperfectly competitive if the firm sets a price-cost markup, which is our model consistent measure of product market power. The labor market setting is defined to be imperfectly competitive if the firm either pays a wage markup or sets a wage markdown. Our model consistent measure of labor market power is either the workers' bargaining power during work-firm negotiations in the former or the wage elasticity of the firm's labor supply curve capturing its wage-setting power in the latter. To establish causal evidence of trade shocks on product and labor market power, we use China's WTO accession in 2001 as an identification strategy. Reducing tariffs on intermediate inputs decreases the likelihood of shifting firms away from an imperfectly competitive labor market setting. Reducing tariffs on final goods increases the likelihood of shifting firms away from setting wage markdowns. Trade liberalization via input tariff reductions increases a firm's price-cost markup but decreases the degree of wage-setting power that it possesses, conditional on the relevant product/labor market setting. Such joint responses of firms' pricing behavior in product and labor markets to trade policy changes are important for understanding the distributional consequences of trade shocks and the underlying drivers of increased inter-firm wage disparities.