Trade costs and multimarket collusion

Abstract

Contrary to conventional wisdom, this article argues that trade liberalization may facilitate collusion and reduce welfare. With the help of a duopoly model in which firms interact repeatedly in multiple markets, we first show that, if trade costs (i.e., tariffs/transport costs) and discount factors are not too high, efficient cartel agreements necessitate the cross‐hauling of goods, as that entails lower deviation incentives. In this setting, we then demonstrate that reciprocal trade liberalization always raises total output when trade costs are within a range whose lower bound exceeds a threshold level, but may reduce total output (and thus be pro‐collusive) when trade costs are below that threshold level.