Preferential Trade Agreements and Multi-Product Firms

Stefan Rouenhoff & Carsten Eckel, University of Bamberg Preferential Trade Agreements and Multi-Product Firms

Preferential Trade Agreements and

Multi-Product Firms

Stefan Rouenhoff & Carsten Eckel

University of Bamberg

11th Annual Conference of the European Trade Study Group

Rome, September 10, 2009


Literature

Preferential trade agreements and FDI• Horizontal FDI as tariff jumping motive and the intention to exploit the

proximity to larger regional markets

• E.g., Motta & Norman (1996), Puga & Venables (1997)

Multi-product firms• High importance of multi-product firms (MPFs)

• Horizontal FDI causes multiple way trade in differentiated final products

• “Cannibalization” of own sales

• E.g., Baldwin & Ottaviano (2001), Eckel & Neary (2009)


Theoretical Framework

• Partial equilibrium analysis

• One monopolistic MPF, located in a third country (C) wants to supply two identical countries (j=A,B)

produces two product varieties (i=1,2), which aresubstitutable, 0<b<1

• Each variety is produced in a separate production plant under constant variable costs c

• Each production plant is associated with fixed costs F

• Unit tariff costs t are identical between all three countries


Theoretical Framework

• Comparison of two economic settings

• No preferential trade agreement between country A & B(non-integrated markets (NIM))

• A preferential trade agreement between country A & B(integrated markets (IM))

No tariff costs between country A & B


Consumers in non-integrated and integrated markets

2

121

2

2i

ii

j xbxx

xUUtility function:

Demand functionVariety 2:

Variety 1:jjj bxxp 211 1 jjj bxxp 122 1


Manufacturing in non-integrated markets

Market supply strategies A1 - A4

Fxxt

xt

Fxxt

xt

xcxp

AB

i

Ai

i

Ai

B

i

B

Aj

ji

i

B

Aj

ji

i

B

Aj

ji

ji

2

2F

21

2

1

2

11

2

1

2

1

2

1

ПA2

ПA4

ПA3

ПA1

Tradecosts

Investmentcosts

Objective functions



Market supply strategies A1 - A4

Fxxt

xt

Fxxt

xt

xcxp

AB

i

Ai

i

Ai

B

i

B

Aj

ji

i

B

Aj

ji

i

B

Aj

ji

ji

2

2F

21

2

1

2

11

2

1

2

1

2

1

ПA2

ПA4

ПA3

ПA1

Tradecosts

Investmentcosts

Objective functions



Country A Country B

Country C

t

t

Production plantvariety 2

Market supply strategy A4




3214 ,, AAAA

Critical tariff rate:

Profit conditions:

b

bF

b

bc

b

bct Invest

NIM 21

)1(4

)21(

)1)(1(

)21(

)1)(1( 22



t

1A2A

4A3A

InvestNIMt maxt0

Profits of market supply strategies

0.84b 0.05,F 0.005,c :Parameters


Manufacturing in integrated markets

Market supply strategies A5 – A7

2

1

11

2

1

2

1

2

i

B

Aj

ji

BA

i

B

Aj

ji

i

B

Aj

ji

ji

xt

Fxxt

F

xcxp

ПA5

ПA6

ПA7

Tradecosts

Investmentcosts

Objective functions



Market supply strategies A5 – A7

2

1

11

2

1

2

1

2

i

B

Aj

ji

BA

i

B

Aj

ji

i

B

Aj

ji

ji

xt

Fxxt

F

xcxp

ПA5

ПA6

ПA7

Tradecosts

Investmentcosts

Objective functions



Country A Country B

Country Ct

Market supply strategy A6

tProduction plantvariety 1




Critical tariff rates:

Profit conditions: 756 , AAA

)1(2)1()1()1)(1( 222 bFbcbct InvestIM

b

bF

b

bc

b

bct Export

IM 21

)1(2

)21(

)1)(1(

)21(

)1)(1( 22



Profits of market supply strategies

t

7A6A

5A

ExportIMt maxt0

0.84b 0.05,F 0.005,c :Parameters


Comparative Static Analysis

t

bHbMbLb

1) (2,

InvestIMt maxt

InvestNIMt

Lt

Ht

Mt

0.05F 0.005,c :Parameters

Investment location

InvestIM

InvestNIM

ExportIM tttt


Comparative Static Analysis

Welfare (Extension I: transportation costs )

jjjj TREUWj

InvestIM

InvestNIM

ExportIM tttt

BIM

BNIM

BIM

BNIM TRTR A

IMA

NIM WW

AIM

ANIM

AIM

ANIM TRTR

AIM

ANIM WW

AIM

ANIM WW , if

, if

b

b

t

c

122

21

b

b

t

c

122

21


Results and Outlook

Relocation of production possible

Both, “tariff jumping motive” and “cannibalization reduction motive” are decisive for market supply stragegy

Welfare decrease possible

Extension II: varying country size

Extension III: varying tariff costs

Documents

Preferential Trade Agreements and Multi-Product Firms