Reductions in Real versus Tariff Barriers: The Impact on Industry Concentration

Economic integration has had ambiguous effects on industry concentration. The literature on the topic proposes various explanations for these empirical findings. This paper provides an additional theoretical argument. It shows that in a world of monopolistic competition, integration alone (modeled as a reduction of trade barriers) may exert opposing forces on industry concentration, depending on whether the barrier consists of real (frictional) or tariff costs. In particular, the Herfindahl index of industry concentration falls for a reduction in real costs, but rises for a reduction in tariff costs. The reason is that real barriers burn up resources, such that industry profitability is reduced, reducing entry, and resulting in fewer firms and a correspondingly higher concentration. Under a tariff barrier, the redistributed tariff revenue stabilizes industry profitability, resulting in more firms and a lower concentration.