More trade, more competition? – Openness and competition policy in developing countries

There is a consensus in the empirical and theoretical literature that more competition necessarily brings lower mark-ups. However, prima-facie evidence in a small developing country (Uruguay) suggests that trade openness was accompanied by a significant amount of exit by domestic firms, and higher prices and mark-ups for those firms remaining in the market. In particular, simple descriptive statistics suggest that trade liberalization was indeed followed by a reduction in mark-ups in the tradable sector, but when the tradable sector is decomposed into import-competing and export-competing, it turns out that in the import-competing sector, mark-ups have increased. How can this be explained? At the theoretical level, the negative link between competition and mark-ups relies on the assumption that demand functions are not too convex so that the elasticity of demand increases with quantities consumed – which is a very restrictive assumption. At the empirical level, before confirming the prima-facie results, it would be necessary to check that they are not driven by unobserved factors or endogeneity. This project will first carefully explore the relationship between mark-ups and trade reform in Uruguay using difference-in-difference techniques, combined with matching techniques. The data source is the firm-level manufacturing survey of Uruguay’s National Institute of Statistics (INE), which is available for the period 1988–1995. It will then explore whether the empirical evidence regarding mark-ups and sales is consistent with the predictions from a more flexible demand framework.