97914 NOTE NUMBER 348 viewpoint PUBLIC POLICY FOR THE PRIVATE SECTOR JUNE 2015 Export Competitiveness Tanja Goodwin and Why Domestic Market Competition Matters T r a d e a n d C o m p e t i t i v e n e s s G l o b a l P r a ct i c e Martha Denisse Pierola 1 This review of the empirical literature shows that industries with more Tanja Goodwin (tgoodwin@worldbank intense domestic competition will export more. Competition law enforcement .org) is a Private Sector can be traced to export performance and is complementary to trade reforms. Development Specialist Pro-competition market regulation that reduces restrictions and promotes in the World Bank Group’s Trade and competition — where it is viable — is an important determinant for trade. Competitiveness Global The elimination of barriers to entry and rivalry and a level playing field in Practice. Martha Denisse Pierola upstream sectors contribute to export competitiveness in downstream (mpierola@worldbank manufacturing sectors. In some sectors, effective competition policy can .org) is an economist in the Trade and Interna- directly lower trade costs. tional Integration unit of The adoption of competition policy is in many ways in particular. Given the complexity of the relation- the Development Research a natural complement to the reduction of trade, ship between trade and domestic competition, the Group, World Bank. investment and services barriers. selection reviewed is narrowed to academic studies Research for this note was — World Trade Organization, 2011 analyzing linkages. Most of this empirical literature supported by the addresses one of these three questions: (i) What governments of Canada, Trade and competition are inextricably linked. is the impact of the intensity of domestic competi- the United Kingdom, As markets integrate, forming global value tion on import and export growth? (ii) What is the and the United States chains, and as trade patterns reflect more impact of competition policy on import and export through the Impact sophisticated production structures, countries’ growth? (iii) What is the impact of pro-competition THE WORLD BANK GROUP Program of the World success in international markets increasingly reforms on firms’ export competitiveness in down- Bank Group’s Trade and benefits from well-functioning competitive stream sectors? 3 Competitiveness Global domestic markets. This has been evidenced in Practice. trade agreements. In 2010, 30 percent of pref- Domestic competition and export erential trade agreements included provisions performance related to competition policy, as well as sector- Empirical evidence reveals that industries with specific provisions with pro-competitive effects less market concentration, more market share on domestic markets. 2 instability, and more perceived competition This review presents study findings regarding export more. This suggests that firms that are the impact of domestic market competition on exposed to more competition in domestic mar- trade performance in general, and on exports kets are more likely to succeed in international p o r t C ompetiti E x port e n e s s W h y D o m e s t i c M a r k e t C o m p e t i t i o n M a tt o m p e t i t i v ene tters markets (See box 1). Indeed, by gaining market five to two between 1989 and 1991. Based share at home and abroad, such firms contrib- on their estimation results, this reduction ute to an economy’s export growth. in domestic competition triggered an annual Some studies find that domestic markets loss in air transport services exports of with several equally sized firms rather than a $6.5 million. few large ones tend to exhibit better export Kim and Marion (1997) find similar evi- performance. Hollis (2003) compares 82 man- dence for a positive relationship between ufacturing industries in seven countries, and domestic rivalry and export performance from finds that relatively higher domestic concen- the U.S. food manufacturing industries. The 2 tration is associated with a smaller domestic self-reported number of domestic competitors share in world output and fewer net exports. was also found to explain export intensity in six Clougherty and Zhang (2008) review 433 spe- major emerging economies (the Arab Republic cific airline routes between 1987 and 1992, as of Egypt, Hungary, India, Poland, South Africa, well as each airline’s number of competitors and Vietnam), as shown in Estrin and others in its home market and share of passengers (2008). on that route. They find that fewer domestic However, in itself, a large market share is competitors lead to a decrease in an airline’s not necessarily related to lower export perfor- market share on international routes. The mance (see an early review by Morgan 1999; number of Canadian carriers dropped from and Iyer 2010). Whereas Zhao and Zou (2002) Box Related findings about competition in the literature on trade and productivity 1 The trade literature finds a consistent stylized fact that the most productive firms of an economy are engaged in export activity. Causality could run both ways. First, firms enter the export market because they already have higher productivity levels— and often higher growth rates of productivity— before they start exporting. Second, firms become more productive as a result of exporting to other markets because of knowledge spillovers and foreign competition. Empirical evidence has been found for both theories. However, literature reviews conclude that the first effect — the “self- selection” effect — dominates the second “learning-by-doing” effect (Wagner 2012). Greenaway and Kneller (2007) and Wagner (2007) find that firms are more productive before they start exporting compared to those that will not export. Furthermore, once firms start exporting, they typically continue exporting. Seminal models by Melitz (2003) and Bernard and others (2003) have introduced effective competition in domestic markets as the mechanism through which more productive firms enter the markets, and through which the most productive competitors win additional market share. This contributes to an increase in aggregate productivity levels and higher exports. Finally, the empirical literature shows that domestic competition is also an important driver of firm-level productivity— even before firms start exporting and importing (see figure below).a Competition Drives Exports through Productivity Competition (Ex-ante) Productivity Trade (exports) Source: Authors. Sources: Wagner (2007, 2012), Greenway and Kneller (2007), Melitz (2003), Bernard and others (2008). a. See Syverson (2011) for the literature review and Kitzmuller and Licetti (2013) for literature from developing economies. conclude that firms are less likely to engage (2008) summarizes two theories with respect in export activity among the 1,700 highly- to the effect of competition law enforcement concentrated Chinese manufacturing and ser- on international competitiveness: (i) a lenient vice firms they surveyed, Guan and Ma (2003) merger control regime may allow for more find that among 213 Chinese industrial firms, concentrated market structures to achieve pro- a firm’s individual domestic market share is ductive efficiency; and (ii) merger control and not a good predictor of export performance. anti-cartel enforcement may safeguard com- Moreover, markets with larger variability in petitive behavior and drive productivity and market structure tend to export more. innovation, thereby achieving greater competi- 3 In Japan, Ito and Pucik (1993) find that tiveness.4 A study in 1990 by Clark, Creswell, industry’s largest companies— the market and Kaserman suggests that merger enforce- “leaders” — have lower export ratios than mar- ment dampens exports, as it may unduly pre- ket followers. Sakakibara and Porter (2001) vent efficiency-enhancing investments and further measure the intensity of rivalry with resource allocations. By contrast, price-fixing market-share instability. They demonstrate enforcement has a positive effect on export that higher annual percentage changes in shares. However, recent empirical evidence market share of the largest firms between 1973 for either of these theories is scarce. and 1990 (as an indication of high competi- One study using data from 11 Organisation tive pressures) is significantly associated with for Economic Co-operation and Development higher world export shares of that industry in (OECD) countries between 1980 and 2003 the early 1990s. shows that the introduction of competition In short, the more competition firms per- law is significantly associated with growth in ceive, the more they export. A study from manufacturing exports (Babool 2007). In Vietnam (Hiep, Nishijima 2009) builds on the the case of Tanzania, Kahyarara (2004) pres- World Bank Investment Climate Survey. Some ents results that suggest the introduction of 1,150 firms reported the degree of perceived competition policy in 1994 was associated domestic competition. The empirical results with growth in exports of Tanzanian firms show that firms that reported facing some or in the manufacturing sector. Furthermore, intense competition, as opposed to no compe- the common perception that Japan’s high tition, have a higher share of direct exports in level of export competitiveness rests on weak total sales. antitrust enforcement, especially with respect to national champions, is debunked by the Competition policy and trade results from Sakakibara and Porter (2001) The limited number of empirical studies about noted earlier. competition law enforcement and trade suggest Some studies also show that the introduction that a country’s export performance benefits of competition law is an effective, and even nec- from antitrust policy — in particular in com- essary complement to pro-trade policies. Such bination with trade reforms. Moreover, the results are in line with the theory that import ample quantitative evidence regarding pro- competition induced by pro-trade policies, by competition market regulation reveals a size- itself, does not effectively discipline dominant able positive impact on exports and imports. firms in non-tradable sectors or sectors with This points to the role of competition policy natural monopolies. It also does not prevent in driving individual firm productivity, as well anti-competitive firm behavior that can restrict as in ensuring efficiency-enhancing resources market access to foreign competitors. and market share reallocation toward more Marinov (2010) compares the pro-compet- productive firms. itive effect of trade and competition policy on Enforcement of competition law aims at firm-level mark-up estimates for over 25,000 ensuring a market structure conducive to com- manufacturing firms in Bulgaria, the Czech petition. It prevents and sanctions anticompeti- Republic, Estonia, Hungary, Poland, the Slovak tive agreements among competitors. Mitschke Republic, and Slovenia. Marinov focuses on E x port C ompetiti v ene s s W h y D o m e s t i c M a r k e t C o m p e t i t i o n M a tt e r s sector-level tariff protection, the number of that harmonizing regulatory standards could final-instance decisions (relative to market size), increase OECD services exports by 30 percent. and the European Bank for Reconstruction and Lennon, Mirza, and Nicoletti (2009) similarly Development index for antitrust enforcement. demonstrate that barriers to entry in domes- He finds that competition policy enforcement tic markets limit trade in services. Schwellnus contributes more to lowering mark-ups than (2007) finds that based on estimation results, trade liberalization. Competition law enforce- if France’s stance on product market regula- ment may further eliminate certain conduct- tion would have been as liberal as the United related barriers to trade induced by domestic Kingdom’s in 1998, its services exports would 4 firms. Miroudot, Pinali, and Sauter (2007) show have been twice as high. that across 82 countries, the volume of imports is positively associated with indicators of the Input sector competition policy and strength of domestic competition law and policy downstream export competitiveness5 enforcement. The empirical literature finds that pro-compe- Pro-competition regulation in domestic tition regulation of input product and services markets has been shown to be correlated with markets contributes to export competitiveness higher trade flows. Several studies employ the of downstream sectors. Indeed, in some sec- OECD’s product market regulation (PMR) tors, it contributes directly via the cost of trade. indicator that measures regulatory barriers to Further, it also benefits imports. At least one entry, as well as rivalry in segments of product study shows that this holds true for antitrust markets in which competition is viable. The enforcement as well. This suggests that well- indicator transforms qualitative information functioning markets for services play a par- on existing laws and regulation into a stan- ticular role in trade and competitiveness of dardized score that captures the restrictiveness other sectors in the economy. For instance, of sector-specific and economy-wide regula- since services such as telecommunications or tion to competition. For example, Nicoletti professional services are often direct inputs and others (2003) demonstrate that exports for manufacturing firms, low quality or high of goods and services are lower and grow more prices for such services limit the final product’s slowly in countries with more restrictive PMR competitiveness. levels. Whereas exports in sectors that rely heavily The OECD (2005) simulated the effect of services inputs have shown extraordinary export simultaneous structural reforms in bilateral growth performance over the last decade, the tariffs, foreign direct investment restrictions, annual export growth in OECD countries could and the level of PMR restrictiveness. Pro- be at least 1 percent larger if the services sectors competitive regulation reforms were “by far the were more open to competition (Barone and largest driver” of the predicted OECD export Cingano 2011). In the 1980s, India’s energy, growth of 30 percent. telecommunications, and transport services As information and communication technol- were provided by state-owned monopolies. ogies allow firms to outsource more tasks and Reforms allowed for private sector participation further “unbundle” production stages, trade and introduced pro-competition regulation. in services can be a prominent driver of export The OECD’s Electricity Communications and growth and efficiency gains (Baldwin 2011). Transport indicator captures these reforms, However, exports of services are significantly and Bas (2014) studies their impact on India’s stifled by legal barriers limiting the number of exports. Bas notes that the change in services competitors in key services and infrastructure regulation between 1994 and 2004 increased sectors— just as services imports are dampened the likelihood that an Indian manufacturing by extensive licensing requirements. Kox and firm would export by 5 to 6 percent. The empiri- Nordas (2007) identify a strong impact of regu- cal estimates further imply that aligning ser- latory heterogeneity on trade, as measured by vices regulation to the average level observed in differences in the PMR scores. They estimate OECD countries would allow for an additional increase in the likelihood of exporting by 2.25 Fink, Mattoo, and Neagu (2002) estimate percent per year. that eliminating both public as well as pri- Berulava (2012) shows that services liberal- vate actions that restrict competition in the ization — such as deep reforms and liberaliza- international maritime transport sector could tion in service sectors including electric power significantly reduce trading costs, thereby supply, railways, roads, telecommunications, boosting export performance. Restrictive and water supply— positively and significantly practices, such as cargo reservation schemes, influences the export intensity of downstream rate-binding or other price-fixing private car- industries in 29 countries in the European and rier agreements increased the costs on goods 5 Central Asian region. carried to the United States alone by up to $3 Francois and Wooton (2010) demonstrate billion. Similarly, Geloso and Shepherd (2011) how anti-competitive regulation in the distri- find that restrictions on freedom of pricing bution sector (road freight and retail market) in air cargo transport have particularly strong in 22 OECD countries significantly reduces negative effects on bilateral trade in parts and the volume of imports from 69 countries in components. 2001. The excessive involvement of profes- Hummels and others (2009) find that devel- sional associations, licensing requirements, and oping countries are particularly affected by price controls in the road transport segments, the lack of competition in transport services. as well as onerous registration and special reg- In a study about the international shipping ulations for large outlets in the retail sector, industry, they calculate the impact on trade were found to impose significant restraints volumes as a result of cargo carriers pricing on imports. Similarly, excessive regulation in above marginal cost. Their findings indicate the distribution sector in developed countries that eliminating market power in shipping is a particularly high barrier for trade flows would boost trade volumes by 15.2 percent from low-income and small countries. Pittman (for Latin America) compared to 5.9 percent (2009), in turn, evaluates specific models of (for the United States). railway sector regulation and traces the influ- ence of the competition policy choices on Conclusion domestic rivalry in key transport industries, Domestic competition promotes firm-specific which in turn determines shipping costs and productivity. It also generates efficiency-enhanc- trade flows. ing reallocation that increases industry-wide Anti-competitive firm behavior in upstream productivity. More intense competition in input sectors dampens downstream exports. Allegra products and services further benefits down- and others (2004) identify intermediate sec- stream producer productivity. Competition tors in Italy with a higher number of sanctions promotes export competitiveness through all of or other interventions by antitrust authorities. these channels. They find that export sectors that are more This review of the relevant empirical litera- dependent on such “problematic” sectors ture has shown that the degree of competi- show lower levels of net exports and also lower tion in a domestic market is a key determinant growth in exports. of its export performance. In line with this Moreover, the lack of competition in some result, competition policy enforcement and, services may directly affect the cost of trade, in particular, pro-competition market regu- often disproportionately. Using evidence from lation, has been found to promote export Argentina and Uruguay, Volpe Martincus and competitiveness. Finally, competition policy others (2014) have derived that for every 1-per- in the upstream markets plays an important cent increase in transport costs, a firm’s exports role in providing downstream exporters with decline by 6.5 percent. The lack of effective high quality and competitively priced input enforcement of anti-competitive behavior is goods and services, thereby boosting their therefore particularly detrimental to trade. competitiveness. E x port C ompetiti v ene s s W h y D o m e s t i c M a r k e t C o m p e t i t i o n M a tt e r s Notes 3. See table 1 in the Annex, which summarizes estimates 1. The authors thank Martha Martínez Licetti for over- from studies that aim at quantifying the effect of some all guidance, as well as Tania Begazo, Najy Benhassine, of these linkages. Chad Bown, Ana Fernandes, Mariana Iootty, Russell 4. Note that the first theory mainly refers to merger Pittmann, Georgiana Pop, and José Guilherme Reis control policy rather than anti-cartel policy. for valuable comments and suggestions. This note 5 This section focuses on the effect of domestic competi- further benefits from discussions and comments by Ana tion and competition policy in upstream sector and down- Goicoechea, Alejandra Mendoza, Massimiliano Santini, stream export performance. Related literature examines and Christine Zhenwei Qiang. the relationship between pro-competition service sector 2. The opening up of domestic markets through trade liberalization and downstream sector productivity (for agreement provisions has been identified as a strategy example, Arnold, Javorcik, and Mattoo, 2011), as well as for- to break domestic political gridlock and enhance mar- eign competition in services sector and downstream export ket competition (Francois and Hoekman 2010). performance (for example, Francois and Woerz 2008). Annex Table Effect of competition policy on trade performance 1 Policy area and country Study Reform Effect Product Market Regulation OECD/Panel Barone and Cingano 2011 Regulations on barriers to entry: Vertical Increase in difference between export growth in integration and market conduct in professional downstream industries that use service intensively and services, telecommunications, transportation those that do not by 0.7–1 percent compared to and energy sectors. countries with tighter service regulation. France Crozet, Milet, Mirza 2012 Restrictions on entry (that is, licenses, Expected rise in firm-level services exports by more administrative handling) and on ongoing than 15 percent following a 10-percent decrease in operations (for example, price controls). restrictiveness. A 5-percent lower likelihood to export to destinations that have a 10-percent more restrictive regulation than other destinations. OECD/Panel OECD 2005 State control, barriers to entrepreneurship, Expected increase of total OECD exports by 30 percent barriers to trade and investment. following a reduction of inward-oriented product market regulation. Panel Kee, Nicita, Olarreaga 2009 Price controls, quantity restrictions, Restrictions add an average of 87 percent to the level of monopolistic measures, technical regulations. trade restrictiveness imposed by tariffs. The countries with the highest ad valorem equivalent of core non-tariff measures are all low-income African countries (Algeria, Côte d’Ivoire, Morocco, Nigeria, Tanzania, and Sudan). Competition Policy Enforcement Panel Miroudot, Pinali, Sauter 2007 Competition law and policy (government A 20-percent growth in imports per a 1-percent intervention, price controls, antitrust law, decrease in domestic competition policy score administrative burden to entry). (pro-competitive reform). 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