firms and markets: from local to global ba festival of science 2005, trinity college dublin section...
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FIRMS AND MARKETS:
FROM LOCAL TO GLOBAL
BA Festival of Science 2005, Trinity College Dublin
Section F (Economics) Presidential Session
9.00 a.m. – 5.30 p.m., 7 September 2005
A one-day conference organised by the Geary Institute (UCD)and the Institute for International Integration Studies (TCD)
FROM LOCAL TO GLOBAL:
FIRMS AND MARKETS
IN INTERNATIONAL TRADE
J. Peter Neary
University College Dublin and CEPR
BA Festival of Science 2005, Trinity College Dublin
7 September 2005
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Introduction
Globalisation
General Equilibrium• Key: Interactions between goods and factor markets
Market Structure• Competition: Perfect or Monopolistic
Neary (JEL 2001, 2003a)
• Oligopoly: Large Firms, entry barriers, strategic interaction
=> “GOLE”: General Oligopolistic EquilibriumNeary (JEEA 2003)
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Plan
Market Structure:• Perfect Competition
• Monopolistic Competition
• Oligopoly
Extensions of GOLE:• Endogenous mode of competition
• Heterogeneous firms and endogenous market structure
Implications for Policy:• Fostering entrepreneurship
• Foreign direct investment (FDI) and trade costs
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Plan
Market Structure:• Perfect Competition
• Monopolistic Competition
• Oligopoly
Extensions of GOLE:• Endogenous mode of competition
• Heterogeneous firms and endogenous market structure
Implications for Policy:• Fostering entrepreneurship
• Foreign direct investment (FDI) and trade costs
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Traditional benchmark:• “Small” firms
• Homogeneous goods
• Production costs independent of firm scale
Pro:• Very adaptable
Con:• Unrealistic
• No allowance for increasing returns, product differentiation, etc.
• e.g., Implausible implications for international production patterns
Perfect Competition
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Equilibrium Production Patternsin Perfect Competition
c
c*a'
a'
O: No home orforeign production
F: Foreign production only
H: Homeproduction only
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Chamberlin (1933)
• “Small” firms
• Differentiated goods
• Declining average costs /Increasing returns to scale
• No perceived interdependence
Pro:
Monopolistic Competition
U x z x z dz[{ ( )}] ( )
0
11
p z Ax z( ) , 1
1
• Precise, tractable, versatile
Con:• Unrealistic
Dixit-Stiglitz (1977) preferences:
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Extensions:• Internal organisation of firms
• Heterogeneous firms
Monopolistic Competition (cont.)
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Oligopoly
Perceived interdependence central
Firms large in their own market• Progress delayed by difficulties of modelling firms large relative to the
economy
• Resolution: Assume many sectors, all small
• So: firms themselves are small in the economy
Demand: “Continuum-quadratic” preferences:
U x z ax z bx z dz[{ ( )}] [ ( ) ( ) ] 12
2
0
1
p z a b x z( ) ' ' ( )
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Oligopoly (cont.)
Simple model to illustrate effects of trade liberalisation
Heterogeneous sectors in 2 countries:• Integrated world market
• Given numbers of firms at home & abroad: n, n*
• Firms in each country have identical costs: c, c*
• Cost configurations consistent with profitability:
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Equilibrium Production Patternsfor Arbitrary Home and Foreign Costs
c
c*
O: No home orforeign production
F: Foreign production only
H: Homeproduction only
a'
a'
HF: Homeand foreignproduction
a
n
'* 1
a
n
'
1
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To embed this in general equilibrium: • Costs depend on technology and wages• Wages (at home and abroad) determined in the
labour markets
Oligopoly (cont.)
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Equilibrium Production Patternsfor a Given Cost Distribution
c
c*
O
HF: Homeand foreignproduction
F: Foreign production only
H: Homeproduction only
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Oligopoly (cont.)
• Specialisation patterns determined as shown• Wages and threshold sectors determined together in
general equilibrium
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Plan
Market Structure:• Perfect Competition
• Monopolistic Competition
• Oligopoly
Extensions of GOLE:• Endogenous mode of competition
• Heterogeneous firms and endogenous market structure
Implications for Policy:• Fostering entrepreneurship
• Foreign direct investment (FDI) and trade costs
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Endogenous Mode of Competition(joint work with Joe Tharakan, Natl. Univ. of Ireland, Maynooth)
“Cournot”/quantity-setting vs. “Bertrand”/price-setting
2-stage capacity-price duopoly game:[Kreps/Scheinkman (BJE 1983), Maggi (AER 1996)]
• Investment in capacity commits a firm to charge higher prices
• The credibility of the commitment depends on , the cost premium of producing above capacity
• If is sufficiently high, then the outcome is “as if” competition was Cournot
Embed this in general equilibrium:• Assume a continuum of sectors z[0,1], with different values of • Assume production (variable costs) uses unskilled labour and investment in
capacity uses (z) skilled labour; wages: w and r
• Threshold sectors are then determined jointly with factor prices
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Heterogeneous Firms and Endogenous Market Structure
Firm heterogeneity in monopolistic competition:[Melitz (Em 2003), Helpman-Melitz-Yeaple (AER 2004)]
• Firms pay a sunk cost to reveal their productivityDraw c from a distribution g(c)
• Given their productivity, they calculate their expected profits and choose to produce or exit
Exit if c < ce where (ce) = 0 or r(ce) = f .
• If exporting and/or FDI require an additional fixed cost, only high-productivity firms will engage in them
• Predictions are consistent with micro-empirical evidence
Extend to a continuum of sectors:• Firms draw a productivity and a sector: {c, z}• Sectors differ in their fixed costs: f(z), f ´ > 0• In equilibrium, sectors have different expected firm numbers
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Equilibrium Expected Market Structure
E(ln2n)
z 1
Monopoly
0
Oligopoly
Monopolistic Competition
1
2
3
4
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Plan
Market Structure:• Perfect Competition
• Monopolistic Competition
• Oligopoly
Extensions of GOLE:• Endogenous mode of competition
• Heterogeneous firms and endogenous market structure
Implications for Policy:• Fostering entrepreneurship
• Trade costs and foreign direct investment (FDI)
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Fostering Entrepreneurship
How to encourage new (indigenous) firms?Monopolistic Competition:• All entrants are de novo and identical
(Melitz: ex ante identical)
• Spillovers from multinationals encourage indigenous entryTheory: Markusen and Venables (EER 1999)
Empirical evidence: Görg and Strobl (EER 2002)
Oligopoly: Entry by diversification much more likely• Successful entrants are frequently incumbents in a related
industry. Theory: Gilbert and Newbery (AER 1982)
Empirical evidence: Geroski (IJIO 1995); Davies, Rondi and Sembenelli (IJIO 2001)
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Dominant view of FDI:– Theory has focused on “greenfield” case
– Mostly horizontal (i.e., concerned with market access)
– Relative to exporting, encouraged by trade costs
– This view consistent with much evidence
– But: counter-factual implication: falls in trade costs should reduce FDIc.f. Ireland in 1990s: huge increase in FDI while trade costs in EU fell
Resolutions:– Export-platform FDI: Falls in internal EU trade costs
– Cross-border mergers: brown not green-field
How to explain cross-border mergers?– M&A’s a huge % of all FDI
– A high % of mergers are cross-border
– Cross-border merger waves linked to market integration[EU Single Market; Mercosur]
Trade Costs and FDI
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How does trade liberalisation affect merger incentives?• No incentive if the 2 merging firms are identical
[Salant, Switzer, Reynolds (QJE 1983): “Cournot merger paradox”]
• BUT: If firms differ in cost, a low-cost/high-cost takeover may be profitable
Trade Costs and FDI (cont.)
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c
c*
Incentives for home firms to
take over foreign
Home firms face similar incentives:
Takeover Incentives
OF
HF
H
Incentives for foreign firms totake over home
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Wage adjustment in general equilibrium:• Assume symmetric countries
• Expanding and contracting firms in both
• BUT: High-cost firms contract by more
• So: Wages fall
Trade Costs and FDI (cont.)
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Cross-Border Mergers Tend to Reduce Wages(unlike greenfield FDI)
c
c*
OF
HF
H
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Conclusion
Different approaches to modelling globalizationHere: Oligopoly in general equilibrium [GOLE]• Continuum of sectors avoids problems of firms being “too large” in the economy
Theoretical Applications:• Endogenous Mode of Competition [Bertrand vs. Cournot]• Heterogeneous Firms and Endogenous Market Structure
• Level of fixed costs determines equilibrium expected number of firms
Policy Applications:• Fostering Entrepreneurship• Trade Costs and FDI
• Standard model predicts that trade liberalisation will lower FDI• Oligopoly model avoids this
More work needed!
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Further ReadingNeary, J.P. (2001): “Of hype and hyperbolas: Introducing the new economic geography," Journal of Economic Literature, 39:2,
June, 536-561.
Neary, J.P. (2002): “"Foreign direct investment and the single market," The Manchester School, 70:3, June, 291-314.
Neary, J.P. (2003a): “Globalization and market structure,” Journal of the European Economic Association, 1:2-3, April-May, 245-271.
Neary, J.P. (2003b): “The road less travelled: Oligopoly and competition policy in general equilibrium,” in R. Arnott, B. Greenwald, R. Kanbur and B. Nalebuff (eds.): Economics for an Imperfect World: Essays in Honor of Joseph E. Stiglitz, Cambridge, Mass.: MIT Press, 485-500.
Neary, J.P. (2003c): “Monopolistic competition and international trade theory,” in S. Brakman and B.J. Heijdra (eds.): The Monopolistic Competition Revolution in Retrospect, Cambridge: Cambridge University Press, 159-184.
Neary, J.P. (2005): “Trade costs and foreign direct investment,” presented at CESifo Summer Institute Workshop on Recent Developments on International Trade: Globalization and the Multinational Enterprise, Venice, July 2005.
[All these papers available at www.ucd.ie/economic/staff/pneary/neary.htm]
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European Trade Study Group (ETSG)7th Annual Conference
University College DublinThursday 8th – Saturday 10th September
www.etsg.org