THE PRO-COMPETITIVE EFFECT OF IMPORTS FROM CHINA: AN ANALYSIS ON FIRM-LEVEL PRICE DATA

1. THE PRO-COMPETITIVE EFFECT OF IMPORTS FROM CHINA: AN ANALYSIS ON FIRM-LEVEL PRICE DATA Matteo Bugamelli, Silvia Fabiani and Enrico Sette (Bank of Italy, Economic Research Department)

2. QUESTIONS • Does product competition from China affects firms’ pricing strategies in advanced countries? • Does increased import penetration of Chinese products cause a reduction of firms’ prices and markups? • Are these effects stronger in less tech advanced sectors where competition is more price-based? • Are these effects stronger for small firms (low productive, low product quality, low skill intensive, low capital intensive, low R&D intensive)?

3. BACKGROUND: THEORY • Pro-competitive effect of trade theoretically well-grounded (Krugman, 1979; Bernard et al, 2003; Melitz, 2003; Melitz & Ottaviano, 2008). Recent contributions: stronger foreign competition is followed by price reductions due to both decreases in markups and increases in average firm productivity (reallocation effects)

4. BACKGROUND: EMPIRICS ON SECTORAL DATA • Auer & Fischer (2008): US sectors more exposed to import penetration from emerging countries recorded higher productivity growth, lower price inflation. • Chen et al. (2009): increased European imports rise industry productivity, reduce markups, slow down production prices

5. BACKGROUND: EMPIRICS ON FIRM-LEVEL DATA • One-off trade liberalization (among others, Pavcnik, 2002). Effects on aggregate productivity growth and margins in emerging and developing countries • US plant data (Bernard, Jensen & Schott, 2006a,b): effects of reduction in inbound trade costs & increase in imports from low wage countries on aggregate productivity growth, firms’ exit. Effects stronger in labor intensive industries

6. BACKGROUND: EMPIRICS ON FIRM-LEVEL DATA • Bloom, Draca & Van Reenen (2008): using plant-level data from 11 EU countries, find that Chinese import competition reduces employment growth (large effect) and increases propensity to adopt ICT (small effect) and plant exit • Abraham, Konings & Vanormelingen (2009): using Belgian firm-level data, show that import competition from low wage countries reduced markups and workers’ bargaining power

7. THIS PAPER • Focus on price effects of foreign competition using firm-level data: complement Bernard et al. • Use a direct measure of firm-level price: improve upon Chen et al. and Auer & Fischer • Estimate impact on markups: avoid indirect estimation methods à la Abraham et al. • Exploit firm heterogeneity

8. THIS PAPER • Use a well-defined measure of foreign (price) competition: imports from China • large and temporally well-defined shock: world export market share from 2.3 in 1990 to 11.2 in 2005. Share over world exports to Italy: from 0.6 to 6.2 in 2005 • mostly price-based competitive pressure • concentrated in Italy’s comparative advantage sectors

9. PREVIEW OF RESULTS • Does product competition from China affects firms’ pricing strategies in advanced countries? YES • Does increased import penetration of Chinese products cause a reduction of firms’ prices and markups? YES • Are these effects stronger in less tech advanced sectors where competition is more price-based? YES • Are these effects stronger for small firms?YES

10. EMPIRICAL SPECIFICATION Optimal pricing under imperfect competition: Take logs and first-differences: • Observe Δlog(p) • Need to proxy for costs and mark-ups

11. EMPIRICAL SPECIFICATION: MARKUPS • Markup is function of: • time-invariant sector component related to technology • firm-level demand (cyclical markups) • competition (domestic and foreign, the latter broken down between import penetration and China’s share over world exports to Italy) • firm size Taking logs and first differences

12. EMPIRICAL SPECIFICATION: UNIT COSTS • Unit costs are function of: • unit wages • unit input costs (intermediate inputs) • labor productivity Taking logs and FD • year dummies: common shock

13. EMPIRICAL SPECIFICATION • Combine previous 2 equations • Lagged values: 1-year delay in price adjustment in the face of shocks (Fabiani et al., 2007) • Always clustering of s.e. by sector (2 digits Nace Rev. 1 classification) • Also show regressions with sector fixed effects

14. ENDOGENEITY • Potential endogeneity of China’s share over world export to Italy: entry of Chinese products may be stronger in sectors where Δprice is higher • IV: China’s share of total world exports (CHINA_WRL). Not affected by evolution of Italian firms’ productivity and prices but by push factors (industrial developments and trade policies in China). • Demand or competition effects? Asian region + US absorb two-thirds of China’s exports in 1998, 65% in 2006 • Unobserved time-varying sectoral factors? Correlation btw CHINA_WRL and world trade is -0.025 • Weak IV? correlation 0.9; F-statistics of excluded instrument; fig

15. CHINA EXPORT SHARE: WRL & IT

16. DATA: SOURCES • Bank of Italy survey (SIM): price data, employees, capacity utilization rate (demand). Only manufacturing firms >=50. Annual data • Company Account Data Service (CADS, Centrale dei Bilanci): wage, input costs, labor productivity, C-4 concentration ratio • World Trade Analyzer (Canada Stat): export flows by product and country (importer & exporter) • OECD-STAN: import penetration • Unbalanced panel: 1990-2006. About 6,300 obs

17. FIRM-LEVEL DATA • ΔP is % change in output price. Highly correlated with PPI • ΔDEM is % change in capacity utilization rate • ΔW is % change in (labor cost/ employees) • ΔIC is % change in (cost of intermediate inputs/employees): changes in prices and outsourcing • ΔTFP is % change in TFP: Levinsohn-Petrin with Melitz’s correction for imperfect competition • ΔSIZE is % change in number of employees • ΔDCOMP is % change in C-4: market share of 4 largest firms in terms of sales at 3 digits (CADS data)

18. WHICH PRICES? • We measure average price change across all goods produced by a firm. • We can say little about quality upgrade (within firm): but it works against us • As shown by ISAE (2009), a firm’s products very unlikely falls into different 2 digits sectors

19. SIM-CADS: DESCRIPTIVE STATISTICS

20. DISTRIBUTION OF ANNUAL PRICE CHANGES, BY YEAR

21. DISTRIBUTION OF ANNUAL PRICE CHANGES, ALL YEARS

22. TRADE DATA • UN-World Trade Analyzer: China’s export market shares (over Italian and world imports) • Product breakdown: 4-digits SITC-Rev 3 class mapped into 2-digits Nace-Rev. 1 • Excluded sectors: subject to strong regulation and taxation or with very few firms: Tobacco, Petroleum & coal products, Computing & office equip.

23. CHINA EXPORT SHARE(Source: WTA, Canada Statistics)

24. BASE REGRESSION

25. ROBUSTNESS • Endogeneity of import penetration. IV: US import penetration • Firms’ exit: results so far interpreted as conditional on firms’ survival. Survival bias? Use CERVED and identify exiting firms: i) more restrictive: only liquidation and failure; ii) less restrictive: also M&A • Outliers: i) sector/year cells with few firms; ii) year 1996-2006 • Others (not shown): i) macro area dummies (NW, NE, C, S); ii) firm fixed effects

26. EXTENSIONS • Since we measure Chinese competitive pressures in Italy, effect should be stronger on firms selling domestically: i) exclude export share>30%; ii) weighted regression; weights: share of domestic sales • Sector heterogeneity • Firm heterogeneity

27. EXPORTERS

28. SECTOR HETEROGENEITY • Why exploiting heterogeneity? i) to test predictions of theoretical models; ii) indirect test of plausibility of causal relationship we identify • Sectors: since focus on price behavior, Chinese competititive pressures stronger where competition is more price-based. In other words, less non-price based: product quality, R&D,… • Measures: skill and R&D intensity (Romalis, 2004). 1998 US data à la Rajan & Zingales (1998) • Remark: we do not claim that product quality is not important in traditional sectors, but that climbing the quality ladder for Chinese competitors is relatively more difficult in sectors with high skill and R&D intensity

29. R&D AND SKILL INTENSITY

30. SECTOR HETEROGENEITY

31. FIRM HETEROGENEITY • Reasonably, competitive pressures are heterogeneous across firms, within sectors • Split firms according to their size (# of employees): • structural feature: minimize endogeneity; • many theoretical arguments support negative relationship btw competitive pressures and firm size

32. WHY FIRM SIZE? • Due to fixed costs, large firms better equipped to R&D (Schumpeter, 1934; Griliches, 1998) and to non-tech innovations (marketing, advertising; Bugamelli, Schivardi & Zizza, 2008) • Small firms are more likely financially constrained (Hubbard, 1998; Angelini & Generale, 2008): lack of financial support to R&D and other non-tech innovation • Positive relationship btw firm size and product quality (Kugler & Verhoogen, 2008; descriptive evidence in SIM) • Bernard et al. (2006a, 2006b): stronger impact on low productive, low capital and low skill intensive firms. In our data: positive (and statistically significant, even controlling for sect and year FE) correlation btw size on one side, and TFP/white collar share/capital intensity on the other

33. FIRM HETEROGENEITY

34. CONCLUSIONS • Increased entry of Chinese imports have lowered price and markup dynamics in Italy • Large effect: 10% increase in China’s export share causes 0.3-0.4 pp reduction in output price dynamics. Larger than that of import penetration • Stronger effect in traditional sectors and on smaller firms • Unveiled the mechanism bringing to trade-induced productivity enhancing reallocations: beginning of the Melitz’ story?

35. THANKS FOR YOUR ATTENTION! matteo.bugamelli@bancaditalia.it

36. EXTRA SLIDES

37. DISTRIBUTION OF FIRMS: VALUE ADDED AND EMPLOYMENT

38. PRICES: SIM VS PPI

39. IMPORT PENETRATION (Source: Oecd)

40. IMPORT PENETRATION: IV

41. OUTLIERS

42. FIRMS’ EXIT