Download Import-as-Market-Discipline in Production Networks

Import-as-Market-Discipline in Production
Networks: Evidence of Thai Manufacturing Sector
Archanun Kohpaiboon
Faculty of Economics, Thammasat University and
and
Juthathip Jongwanich,
School of Management, Asian Institute of
Technology
Issues

How firms change their pricing behavior in response
to threat from imports remains interesting to the
international economics literature.

Generally, imports can force firms to set price
competitively and improve the efficient use of limited
resources.

The effect of import on price setting behavior is
known as import as a market discipline hypothesis
(Levinsohn,1993).
What makes the issue interesting is the mixed
outcome in empirical studies.

Negative relationship
-
Esposito & Esposito (1971)
Pagoulatos & Sorensen
(1976)
Pugel (1980)
Lyons (1981)
Geroski (1982)
Neuman et al. (1984)
Chou (1986)
De Ghellinck et al. (1988);
Levinsohn (1993)
Katies & Peterson (1994)
-
-
-
-

Positive relationship
- Urata (1979);
- Pagoulatos & Sorensen
(1981)
- Nolle (1991)
- Ståhlhammer (1991, 1992)
- Field & Pagoulatos (1994).

Interestingly, since 1990 global production network has
gained its relative importance in global trade, reflecting
by the rapid expansion of trade in parts and components
(Athukorala, 2011).

Intermediates like parts and components traded under
the production network are far different from those
traded in the arms’ length transaction.

Sometimes, we cannot be noticed by its appearance
(reflected by serial numbers), e.g. specific integrated
circuits jointly developed between Celestica and
Panasonic for Flat screen TVs (Kohpaiboon, 2011).
From the most capital intensive activities like R&D, Product
development and design to the most labor intensive activity like
assembly
Examples
Stage 5
Stage 4
Country D
Stage 3
Country C
Stage 2
Country B
Stage 1
Country A
Example: Apple iPhone 3G
Y-O-Y Export Growth (%)

Given such difference, therefore, the effect of import on
firms’ price setting behavior would be different
between network and non-network trade.

This issue is highly policy relevant for developing
countries which are still reluctant to continue trade
liberalization (e.g. selective approach and rely on tariff
exemption/rebate schemes) as well as in a period of a
rise of protectionism threat amidst the global economic
recession.

Evidence of gains from trade liberalization is still
needed.
Paper

Examine the import-as market discipline hypothesis in
Thai manufacturing with a hypothesis of possible
different effect of fragmentation-driven parts and final
goods imports, using the latest available industrial
census (2006) is used.

Thai manufacturing has long experience participating in
the production network.

Thailand still has high nominal protection by the
regional standards (Jongwanich & Kohpaiboon, 2007).
Analytical Framework

The effect of import on price setting behavior (how different
between price and marginal cost) is based on the fact that
imports and domestically produced goods are close
substitutes.

The more the imports, the greater the pressure on price
narrowing a gap between price and marginal costs. It is
unlikely for firms to set price far above marginal costs (i.e.
improve efficient use of resources).

As argued in Lopez and Lopez (1996), the net effect depends
on the oligopolistic response of firms to changes in imports

In some cases where domestic firms cut their output in
response to import surges, the net effect on price would
be less.

Our core hypothesis in this paper is a possible different
effect of fragmentation-driven parts imports as opposed
to final good imports.

The disciplining effect of import would be stronger in
the network trade (the network import has stronger
effect in narrowing the gap between price and marginal
cost).

Given the fact that developing countries have strong belief
in cascading tariff structure to promote local production,
type of import goods would be dominated by intermediates
used for finished goods production. It would be difficult to
find close substitute products in domestic market. The
expected disciplining effect would be limited.

It is possible to have finished goods imports but they are
likely to be totally different from locally manufactured
ones. As reflected in the previous studies (Kokko, 1994;
Moran, 1998), high nominal protection encourages the entry
of local enterprises but they might focus certain niches that
are not directly competing with imports.

By contrast, in the production network, the disciplining
effect would be stronger.

Decision to fragment the whole production process\(inhouse vs. outsourced), where to be produced (home vs.
aboard) is systematically determined to ensure the cost
competiveness of final goods.

Hence, oligopolistic responses like change output level
in responses to import changes are less likely to work in
the network trade.

Regard to the disciplining effect (pressure on prices)
competition found at the final goods between leading
MNEs can easily pass through to each stage of
production in the network.

Inefficiency occurring in any stage of production can
create significant impact on final goods competitiveness.
It is in line with the effect of tariff on production
network (Yi, 2003).

Hence, firms in the networks must work together to
ensure all non-price qualifications are fulfilled given the
price target . The joint work even commences before
actual production.

Parts imports could occur in two circumstances;

The first is parts imports are used in the later stage of
production. However, their output can be classified in
the same category under the standard industrial
classification like 4-digit ISIC.

For example, 7 out of the top 10 of P&C exports are on
the top-10 of P&C Imports calculated at the 5 digit
SITC level of disaggregation, suggesting the high level
of intra-product trade.

Hence, the disciplining effect is still observed.

The second is the imports are used by specific
customers which are in the different industry. Such
parts are tailored to specific uses in the later production
stage and are not necessarily substitutes to products
which are classified in the same category.

Even though the second is hard to refute its possibility,
it is less likely due to the lucrative sale volumes from
the production network. This would encourage
domestic enterprises enter and results in an increase in
competition.
Measure the extent to which the industry
participates in the production network

The ratio of parts to total goods import values, is used to
measure the extent to which the imports are driven by the
network trade.

We use the list of parts which is a result of a careful
disaggregation of trade data based on the Revision 3 of
the Standard International Trade Classification (SITC,
Rev 3) extracted from the United Nations trade data
reporting system (UN Comtrade database) firstly
developed in Athukorala (2003) and further extended
(adding lists of parts found in the firm interview) in
Athukorala & Kohpaiboon (2009)
The Model
PCM ij
IMPj
 1   2 PC j
Data Cleaning and Variable Measures

Data for the study are compiled from unpublished
returns to the Industrial Census 2006, the latest
industrial census available, conducted by the National
Statistics Office (NSO).

After cleaning criteria are applied, the remained
samples are 24,696, accounting for 75% of the
Thailand’s manufacturing gross output and 62% of
manufacturing value added in 2006.

The census was cleaned up by
checking duplicated samples.
 delete establishments which had not responded to
one or more the key questions such as sale value,
output and which had provided seemingly
unrealistic information such as negative output
value.
 Delete micro-enterprises defined as the plants with
less than 10 workers.
 7 industries that are either to serve niches in the
domestic market (e.g. processing of nuclear fuel,
manufacture of weapons and ammunition)

Econometric Procedure

OLS regression while paying attention on possible
effect of outliers and problems emerged from clustered
data.

Several robustness tests were undertaken.




Price-cost margin (A ratio of output/value added)
How to measure import penetration (Denominator: including
or excluding X)
How to measure the plant’s foreign ownership
Econometric procedure (Quantile vs. OLS regression; 2SLS
and 3 SLS for Simultaneity problems)
Result: OLS without outliers
(Equation 6.3)
K
PCM j  .  0.72  0.04    0.05 sizeij  0.05 mktij
( 27.2)***  35.9 *** L
 11.9 ***
 ij  47.6***
 0.06 developedij  0.001 otherforij
 7.4 ***
 5.1***
+ 0.04 IMPj  0.11 PC j * IMPj
 2.5***
 3.5***
 0.007 EOS j  0.001 XOR j * EOS j
 5.1***
 2.3***
 0.0003 FOR  0.13 CR j  0.23 OG j
1.8*
 6.9 ***
 7.6 ***
AdjR  0.306; # obs  23, 044; F  stat  432.25( p  0.00)
2
Discussion on the effect of imports on
prices

In all specifications and robustness checks (Tables 6 and
7), our finding supports the formulated hypothesis.

For the final goods imports (i.e. ), there is a positive
relation between PCMV and IMP.

When imports surge, domestic firms tend to cut their
output to avoid direct competition with the import goods.

Note that avoiding direct competition could be done by
producing different goods serving for certain niche in
the local market. Fabric and machinery are the
example.

All other things being equal, the disciplining effect of
import would be negligible and the positive relationship
perhaps reflects extra profit in the relatively less
competitive environment there.

By contrast, there is the net disciplining effect of import
in the production network.

In the production network, firms work together long
before mass production actually take place to ensure that
they reach price target as well as satisfy with non-price
qualification.

Since the lead firm in the network usually multinational
enterprises utilizes their global network in setting price,
price setting is approaching to the perfectly competitive
market environment, reinforcing the disciplining effect of
imports.
Conclusion and Policy Inferences

Our finding that the stronger disciplining effect is found
in the production network highlights benefit of
participating in the production network in terms of
efficient use of resources.

It would be difficult for indigenous firms to participate
and enjoy the lucrative sale volume in the network in
presence of cascading tariff structure and extensively
use of tariff exemption.

Rationalizing tariff structure and neutralizing economic
incentives are needed.