The heterogeneous competitive effects of trade and foreign direct investment: Firm‐level evidence for European countries

Abstract

and Leuphana University L€ uneburg, L€ uneburg, Germany | INTRODUCTIONThis study evaluates the pro-competitive effect of foreign market penetration with a broad interindustry and cross-country database of European manufacturing firms. The main contribution is an analysis of the heterogeneous effects of different modes of foreign market penetration, imports and inward foreign direct investment (FDI), which have been assigned fundamental differences by economic theory. In empirical studies, these differences have been neglected in relation to competitive effects.Foreign market penetration has gained relevance for the European competitive environment in an EU single market framework since the latest large-scale accession in 2004 and in the context of recent free trade negotiations. The coexistence of imports and FDI in particular is also of increasing empirical importance due to a massive relative increase in the latter in the past decades.The impact of increasing foreign competition on domestic markets has long been studied both theoretically and empirically. A pro-competitive effect of foreign competition is predicted by international trade models with imperfect competition due to a market expansion and an industry restructuring in favour of more efficient firms. This pro-competitive effect, in terms of decreasing markups, has been traditionally tested using some measure of import penetration as a proxy for trade openness and has found general support.A more recent strand of the empirical literature focuses on inward FDI as a second channel for foreign market penetration, which may also have a positive impact on markups through positive spillovers. Another reason why imports and FDI may affect markups differently can be derived straightforwardly from theories of international trade and heterogeneous firms that predict a productivity advantage of firms undertaking FDI. Consequently, competing with foreign firms via imports should mean competing with less productive firms as compared with a situation of competition with foreign multinationals that produce on the spot.

Working capital management, financial constraints and exports: evidence from European and US manufacturers

“…This corporate database contains comparable financial and managerial information for companies worldwide and has been used extensively in studies dealing with multinational companies (Fariñas et al. 2018 ; Weche 2018 ). 7…”

“…Nevertheless, although Orbis is biased towards large companies, the representativeness of the sample is not affected since it covers a large set of manufacturers in the OECD countries (Fariñas et al. 2018 ; Weche 2018 ).…”

FDI, Market Power, and Markups: Evidence from Vietnam

“…Cross-country studies by Rutkowski (2006), Weche (2018), andBitzer andGorg (2009) find some evidence that FDI increases competitiveness and reduces markups, but the results vary across countries, with some experiencing lower markups and others experiencing higher markups. Additionally, when there is statistical significance, it is often weak and depends on model specifications.…”

“…Additionally, when there is statistical significance, it is often weak and depends on model specifications. One possible explanation for the mixed results offered by Weche (2018) is that the positive spillovers and competitive impacts of FDI cancel each other out or vary in magnitude across countries.…”

“…Most country-level studies on this topic rely on accounting-based price-cost margins, concentration, or entry and exit dynamics to measure market power and focus on high-income settings (Abolhassani & Danakol, 2019;Bottasso & Sembenelli, 2001;Chung, 2001;Forte & Sarmento, 2012). While some recent studies compute firm-level markups following De Loecker and Warzynski (2012), many such studies are cross-country in nature, raising questions of comparability across contexts (Bitzer & Görg, 2009;Rutkowski, 2006;Weche, 2018). Our paper builds upon this base by analyzing economic markups in a developing country setting.…”