Domestic competition, industrial efficiency and trade liberalization in Korean industries.

Abstract

In studies of trade policy and market structure, increased domestic competition is often cited as one source of welfare gains from trade liberalization (Helpman and Krugman, 1991). In a market characterized by entry barriers, trade protection typically leads to the oligopolization of the domestic market by a few firms, allowing them to exercise market power. However, trade liberalization improves economic welfare by restricting market power through increased import competition. This argument is in fact a hypothesis about how firms respond to a change in trade policy, and so needs to be tested with firm-level data. The literature on trade policy and development also frequently emphasizes improved industrial efficiency as another source of welfare gains from trade liberalization (Tybout, 1992). First of all, trade liberalization enhances efficiency in production by stimulating domestic firms to adopt new technology and reorganize their operations to compete with foreign producers. Moreover, trade liberalization improves overall efficiency in an industry by forcing inefficient firms to scale down or exit the market and by shifting production toward firms with higher productive efficiency. The main purpose of this study is to investigate whether trade liberalization increases domestic competition and improves industrial efficiency within the context of Korean industries, which have experienced a course of trade liberalization since the mid-1980s. First of all, to examine the competitive effect of trade liberalization, this study constructs a structural econometric model, and estimates the changes in price-marginal cost markups during trade liberalization periods by using firm-level data from 1983 to 1992. This study then finds that price-marginal cost markups tend to decline with trade liberalization, in particular, in imperfectly competitive industries, which provides strong evidence for the hypothesis that trade liberalization increases domestic competition. Furthermore, to investigate the effect of trade liberalization on industrial efficiency, this study adopts a stochastic frontier model, and estimates time-series of frontier technology, firm-specific efficiency and industry-wide efficiency by employing the firm-level panel data. By relating these estimates of efficiency to alternative measures of trade liberalization, such as tariff rates and import penetration ratios, this study then finds that trade liberalization has a significantly positive relationship with industrial efficiency growth, supporting the argument that trade liberalization improves efficiency in domestic industries.