Buyer power and supplier incentives

This paper analyzes the origins and welfare consequences of buyer power. We show that if suppliers are capacity constrained or have strictly convex costs, there are two different channels through which large buyers can obtain more favorable terms from their suppliers. In particular, we show how the presence of large buyers can then erode the value of suppliers’ outside option. Somewhat surprisingly, we show how this can induce suppliers to undertake strategies that lead to higher output and potentially higher welfare.     

Supply and quality choices in private child care markets: Evidence from São Paulo

Many developing countries have adopted the market approach for expanding the supply of child care, but little is known about the economic behavior of independent providers. Drawing on uniquely rich census data on child care providers from São Paulo, we document three main facts: (1) the stock of private suppliers is considerably larger in high-income city districts; (2) the quality of private provision – as measured by teachers' schooling, group size and equipment – is highly heterogeneous across space and increases systematically with local household income; and (3) a considerable share of centers operates below recommended (but not regulated) quality standards, especially in low-income districts. These findings are consistent with a model of endogenous entry and quality choices by heterogeneous providers. Market-driven heterogeneity in the quality of provision across space is an important consideration for the design of regulations in child care markets.     

The trade reducing effects of market power in international shipping

Developing countries pay substantially higher transportation costs than developed nations, which leads to less trade and perhaps lower incomes. This paper investigates price discrimination in the shipping industry and the role it plays in determining transportation costs. In the presence of market power, shipping prices depend on the demand characteristics of goods being traded. We show theoretically and estimate empirically that ocean cargo carriers charge higher prices when transporting goods with higher product prices, lower import demand elasticities, and higher tariffs, and when facing fewer competitors on a trade route. These characteristics explain more variation in shipping prices than do conventional proxies such as distance, and significantly contribute to the higher shipping prices facing the developing world. A simple back of the envelope calculation suggests that eliminating market power in shipping would boost trade volumes by 5.9% (for the US) to 15.2% (for Latin America). Our findings are also important for evaluating the impact of tariff liberalization. Cargo carriers decrease shipping prices by 1–2% for every 1% reduction in tariffs.     

Buyer investment, export variety, and intrafirm trade

This paper studies a model of buyer investment and its effect on the variety and vertical structure of international trade. A distinction is made between two types of buyer investment: “Flexible” and “specific”, which differ in the ability of a buyer to match with a seller. The interaction of buyer investment with the entry and pricing incentives of suppliers are analyzed. It is shown that (i) there can be multiple equilibria in the variety of products traded, and (ii) less product variety is associated with more intrafirm trade. The possibility of multiple equilibria is consistent with the observation that some similar economies, such as Taiwan and South Korea, differ substantially in their export varieties to the U.S. A cross-country empirical analysis confirms the negative correlation between export variety and intrafirm trade.     

The better you are the stronger it makes you: Evidence on the asymmetric impact of liberalization

This paper shows how trade liberalization can have an asymmetric effect on heterogeneous firms. It develops a neo-Schumpeterian growth model predicting that the impact of liberalization on economic performance is positive “on average”, but more advanced firms benefit more. These predictions are tested using Mexican plant-level data confirming that, under NAFTA, the liberalization spurred productivity growth on average. However, the empirical analysis goes beyond estimating the average effect of liberalization and shows that more advanced firms benefited disproportionately more from the liberalization. Focusing on the mechanisms explaining these results, the paper shows that the results are not just driven by an increase in input usage and investments, but rather by innovative and managerial efforts as they are significantly stronger in those sectors where the scope for innovative activities is larger.     

Temporary partnership and subcontracting: Pre- vs. post- award outsourcing in public procurement

We empirically compare bids (i.e. prices) from temporary partnerships (TPs), that outsource part of the contract before the auction, and firms that outsource afterwards. Using a comprehensive dataset on procurement auctions for public works in Valle d’Aosta (Italy), we find that the timing of outsourcing affects the bids and the probability of winning the auction. Specifically, TPs bid closer to the payoff maximizing offer and are more likely to win. Hence, the price paid by the public buyer is lower. These results are supported by a simple theoretical setting showing that, by pre-committing to a TP, suppliers have a lower risk of being “held up” by subcontractors than firms that outsource part of the work after the bidding phase. Our results show the advantage for TPs of freely choosing partners, size and boundaries before the auction, highlighting their potential in fostering the effective participation in public procurement procedures of Small and Medium-sized Enterprises (SMEs).     

Mix‐and‐match divestitures and merger harm

We consider the effects of a merger combined with a divestiture that mixes and matches the assets of the two pre‐merger suppliers into one higher‐cost and one lower‐cost post‐merger supplier. Such mix‐and‐match transactions leave the number of suppliers in a market unchanged but, as we show, can be procompetitive or anticompetitive depending on whether buyers are powerful and on the extent of outside competition. A powerful buyer can benefit from a divestiture that creates a lower‐cost supplier, even if it causes the second‐lowest cost to increase. In contrast, a buyer without power is always harmed by a weakening of the competitive constraint on the lowest‐cost supplier.     

Product differentiation, process R&D, and the nature of market competition

We investigate the relationship between process and product R&D and compare the incentives for both types of R&D under different modes of market competition (Bertrand versus Cournot). It is shown that: (i) process R&D investments increase with the degree of product differentiation and firms invest more in product R&D when they can do process R&D than when they cannot; (ii) Bertrand firms have a stronger incentive for product R&D whereas Cournot firms invest more in process R&D; and (iii) cooperation in product R&D promotes both types of R&D relative to competition whereas cooperation in both types of R&D discourages R&D relative to cooperation in just product R&D.     

Bribery solicitations and firm performance in the Latin America and Caribbean region

This study shows that for firms in the Latin America and Caribbean region, bribery significantly distorts firm growth. Firms that were solicited for bribes when conducting business transactions – such as applying for permits, electricity, or water connections – have 23% lower annual sales growth than firms that do not face such solicitations. Moreover, these distortions are more severe for low-revenue-generating and young firms. Using the instrumental variables method on cross-sectional data as well as evidence from panel data, the authors show that these results are robust to different specifications and the use of different sub-samples.     

Firms’ skills as drivers of radical and incremental innovation

Using firm level data from the Irish Community Innovation Survey 2008–2010 we analyse the importance of eight skill sets for the innovation performance of firms. We distinguish between radical and incremental innovation. Our results suggest that there is substantial heterogeneity in the importance of skills for different types of innovation and that some skills are best sourced from outside the firm while others are best developed in-house.     

Group insurance and lending with endogenous social collateral

We construct a dynamic model of self-enforcing insurance provision and lending to a community of borrowers who are connected by risk-sharing arrangements that are themselves subject to enforcement problems, as in Kocherlakota (1996). We show that an outside lender offering constant-consumption contracts can earn a higher profit if he conditions his repeated interactions with each borrower on the history of his interactions with all the group members (a joint liability contract), rather than on his history with that borrower only (individual liability contracts). This result holds even in the absence of informational asymmetries. The observation driving it is that with individual liability contracts, a joint welfare-maximizing group may prefer to have one or more group members default on their contracts, so that the group can consume a mix of outside funds and the defaulters' stochastic income. One contribution of our work is to give precise economic content to the concept of “social collateral” as the per-agent surplus from group risk-sharing over autarky. The group can deter its members from defaulting on their contracts with the principal by threatening to reduce that surplus.     

The impact of bargaining on markets with price takers: Too many bargainers spoil the broth

In this paper we study how bargainers impact on markets in which firms set a list price to sell to those consumers who take prices as given. The list price acts as an outside option for the bargainers, so the higher the list price, the more the firms can extract from bargainers. We find that an increase in the proportion of consumers seeking to bargain can lower consumer surplus overall, even though new bargainers receive a lower price. The reason is that the list price for those who do not bargain and the bargained prices for those who were already bargaining rise: sellers have a greater incentive to make the bargainers’ outside option less attractive, reducing the incentive to compete for price takers. Competition Authority exhortations to bargain can therefore be misplaced. We also consider the implications for optimal seller bargaining.     

Downstream merger with upstream market power

We examine how a downstream merger affects input prices and, in turn, the profitability of a such a merger under Cournot competition with differentiated products. Input suppliers can be interpreted as ordinary upstream firms, or trade unions organising workers. If the input suppliers are plant-specific, we find that a merger is more profitable than in a corresponding model with exogenous input prices. In contrast to the received literature, we find that it can be more profitable to take part in a merger than being an outsider. For firm-specific input suppliers, on the other hand, results are reversed. We apply our model to endogenous merger formation in an international oligopoly, and show that the equilibrium market structure is likely to be characterised by cross-border merger.     

A solution to the hold-up problem involving gradual investment

We consider a setting in which the buyer's ability to hold up a seller's investment is so severe that there is no investment in equilibrium of the static game typically analyzed. We show that there exists an equilibrium of a related dynamic game generating positive investment. The seller makes a sequence of gradually smaller investments, each repaid by the buyer under the threat of losing further seller investment. As modeled frictions converge to zero, the equilibrium outcome converges to the first best. We draw connections between our work and the growing literature on gradualism in public good contribution games and bargaining games.     

Does trade stimulate product quality upgrading?

This paper investigates whether increased import competition leads firms to engage in incremental innovation reflected in product quality upgrading using Chilean manufacturing firm‐product data and measuring product quality with unit values (prices). We identify causal effects of import competition using an effective trade barrier measure – transport costs – as instruments for import penetration ratios across industries. Transport costs have a negative and significant effect on product quality. The evidence suggests that estimated unit value increases capture product quality upgrading, imports’ competition effects drive quality upgrading, and benefits depend on firms’ industrial specialization. Easier access to intermediate inputs also fosters quality upgrading.     

Why don't firms export more? Product quality and Colombian plants

Exporting firms around the world ship only a small fraction of their output overseas. For firms in a large country, such as the United States, this behavior can be explained by the existence of a large domestic market. For firms in a small lower income country, such as Colombia, the lower share of exports remains a puzzle. This paper begins by illustrating the failure of current models to explain plant export patterns in Colombia. Even models that do well in describing the US export distribution fail when confronted with the Colombian data. In response to this puzzle, this paper suggests that Colombia's export distribution can be explained with a two-dimensional productivity space where output productivity is considered separately from quality productivity. Predictions of this theory are tested on Colombian plant level data from 1981–1991. Overall, product quality is shown to be a significant factor in explaining the tendency for Colombian plants to under-export manufactured goods to the United States.     

Multi-attribute procurement auctions with risk averse suppliers

We analyze multi-attribute procurement auctions with risk-averse suppliers. As the number of suppliers increases or the suppliers become more risk-averse, the equilibrium bidding price decreases under the first-score auction but remains the same under the second-score auction. A buyer prefers the first-score auction.     

Stages of diversification in a neoclassical world

Recent research has documented a U-shaped industrial concentration curve over an economy’s development path. How far can neoclassical trade theory take us in explaining this pattern? We estimate the production side of the Heckscher–Ohlin model using industry data on 44 developed and developing countries for the period 1976–2000. Decomposing the implied changes in industrial concentration over time shows that at least one third of these changes seems to be explained by a Rybczynski effect. This result suggests that capital accumulation led poor countries to diversify their industrial production, while rich countries made their production more concentrated in highly capital-intensive industries.     

Buyer search and price dispersion: a laboratory study

We study markets with costly buyer search in which sellers simultaneously post prices. Buyers costlessly observe one or (with probability 1−q) two of the posted prices, and can accept one or pay to search again. The experiment varies q, the search cost, and the number of buyers. Equilibrium theory predicts a unified very low (high) price for q=0 (q=1) and predicts specific distributions of dispersed prices for q=1/3 and 2/3. Actual prices conform closely to the predictions in some treatments. Buyers’ reservation prices are biased away from the extremes, however, and sellers’ prices have positive autocorrelation and cross-sectional correlation.     

Credit constraints,inequality and the growth gains from trade

This paper tests the hypothesis that, in the presence of credit constraints, higher wealth inequality affects negatively the growth gains from trade liberalisation. Variations in the growth rate of value added–decomposed in the growth rate of the number of establishments and the growth rate in average size–of manufacturing industries in 34 developing countries before and after trade liberalisation are used to study the effects of inequality on the difference in growth under liberalised and nonliberalised regimes. The results show that the number of firms in industries with high dependence on external finance in countries with higher inequality grow significantly slower, in both statistical and economic terms, than in industries with low dependence on external finance in countries with lower inequality following a trade liberalisation relative to the closed-economy period.