Productivity, pricing power, and exports

Atsuyuki Kato

A large literature shows the importance of firm heterogeneity in determining trade patterns. This column discusses policy implementation issues related to the ‘new new trade theory’. The nature of an export good – be it consumption or production oriented – influences the importance of firm productivity in the export decision. The relationship between productivity and markups also varies across industries; pro-export policies must take account of this, lest they exacerbate distortion.

In the last decade many economists and policymakers have been interested in the relationship between firm heterogeneity and exports. As economies globalise , it has become important to understand this relationship in order to devise effective industrial policies.

In academia, models by Melitz (2003) and Helpman et al. (2004) suggest that productive firms develop external markets by foreign direct investment (FDI) and exports, while less productive firms focus on domestic markets. Many empirical papers examine such implications and obtain supportive results. Loecker and Warzynski (2012) examin the relationship with markups and found that exporters have higher markups on average as well.

Designing policy

What policy implications are obtained from those findings? This is an important question for a country such as Japan where export plays a key role in growth in the face of a long lasting population decline.

For the last couple of decades, Japanese firms have constructed sophisticated regional production networks across Asia. They have sliced up their production processes, allocated them to different countries based upon comparative advantages, and connected them as value chains through trade. On the other hand, they have earned value added from direct and indirect exports to the western countries, in particular the US. Their exports to Asian countries are thought to be more production-oriented while those to the United States seem to be consumption-oriented.

How is firm heterogeneity related to this difference? To answer this question, I estimated the productivity and markup premiums of export by region (Kato 2014). The results show that export to Asian countries has both productivity and markup premiums while that to North America (largely to the US) only has a markup premium. This indicates that productivity is a key factor for production-objective exports while differentiation from rivals is more important for consumption-objective exports. In addition, a markup premium on exports to Asia also implies that Asian countries have become more important as consumption markets. Therefore, the industrial policies effective in promoting export are thought to be different based on their export markets, reflecting differences in the major exports. This analysis also may give some hints as to the reason why the Japanese consumer electronics manufacturers have lost their competitiveness in the global market. They failed to differentiate their products in the major markets – although they still possess high skill levels and technologies.

The role of market structure

The structure of market competition should also be considered carefully. Table 1 presents the correlation coefficients between productivity and markup by industry. The relationship between productivity and markups varies considerably across industries. In some industries – such as foods and beverages and general purpose machinery – firms can pursue higher productivity and higher markups simultaneously. In the markets for textiles, plastic and rubber products, glasses and ceramics, and information and communications electronics, high productivity and markups seem to be incompatible.

It follows that the desirable strategies for firms are thought to be different across industries, and it is important to identify under what conditions such competition is formed when devising the effective industrial policies. Policies may enlarge market distortion if higher markups are generated due to some obstacles to competition, such as irrelevant regulations or market unfriendly conventions. Participation rates for exporting are significantly different across industries as well. Industrial policies that promote export can give preferential treatment that works against global trade liberalization, hurting existing exporters in industries such as food and beverages, textiles and wood, and paper. To avoid this, industrial policies should be designed to increase export opportunities for both current and potential exporters, together with reforms toward more competition-friendly markets.

Conclusion

Regional trade agreements such as the Trans-Pacific Partnership (TPP) and the Regional Comprehensive Economic Partnership (RCEP) may work as an effective industrial policies. RTAs can increase opportunities to export through the reduction of various trade costs (such as administrative costs and political uncertainty) while simultaneously promoting market-friendly reforms. In the framework of RTAs, the government can support export activities conducted by domestic firms through costless and market-friendly measures. It is essential to conduct numerous studies that incorporate firm heterogeneity into international trade as well as industrial organization in order to provide useful information for those policy measures.

Table 1. Correlations between productivity and markups, and export participation rates

Note: Author’s own calculation

Editor’s note: The main research on which this column is based (Kato 2014) first appeared as a Discussion Paper of the Research Institute of Economy, Trade and Industry (RIETI) of Japan.

References

Helpman, E, M J Melitz, and S R Yeaple (2004), “Export Versus FDI with Heterogeneous Firms”, American Economic Review, 94, 300-316.

Kato, A (2014) “Does Export Yield Productivity and Markup Premiums?: Evidence from the Japanese manufacturing industries”, RIETI Discussion Paper, 14-E-037.

Loecker, J D and F Warzynski (2012), “Makups and Firm-Level Export Status”, American Economic Review 102, 2437-2471.

Melitz, M (2003), “The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity”, Econometrica 71, 1695-1725.