THE PATTERN OF TRADE
A standard result of trade theory is that international trade limits the abuse of domestic monopoly power. Consider a monopolist in a small country, with constant or increasing marginal costs, faced by a world price too low for exporting to be profitable. In such a case, a domestic monopoly will charge a higher price than competitive tariff permits the exercise of monopoly power, and, with a domestic monopoly, the tariff, which is prohibitive to imports, is higher than with a perfectly competitive industry. A nonprohibitive tariff, like price ceiling, acts as an effective antitrust policy.
These conclusions are all straightforward extensions of microeconomic theory and have long been accepted as one of the arguments for free trade. The empirical significance of trade liberalization as a means of increasing welfare by reducing monopoly power is often assumed but not conclusive.
We proceed in this paper as follows. In Section 1 we present the basic analytical model, involving a domestic distribution sector with market power. It sources both internationally and domestically. We work with this model to examine the impact of imperfect competition in services for the pattern of trade in goods. In Sections 2 and 3, we examine the impact on gains from trade for both importers and exports. In section 4 we then present the Sino-African trade.
1-The Basic Model
We focus on the market for imports of a good q that competes directly with a domestic industry. Our primary interest is in the domestic sale and distribution network which we assume to be less-than-perfectly competitive. It exercises market power in sourcing from both domestic and foreign suppliers, and in sales to final consumers.
Imports are supplied by competitive, overseas producers. Export and domestic supply are imperfectly elastic. Consequently, due to increasing marginal cost of production, the importing country has some degree of monopoly power in trade. It subjects trade in these goods to an import tax at rate t. This creates a wedge between the CIF price and the landed (that is, after duties are paid) import price . Export supply is represented by the inverse supply function (1).
where is the export price at the border while landed prices inclusive of tariffs are
Similarly, domestic supply is an increasing function of domestic price, as reflected in the inverse domestic supply schedule (3).
Consumer demand for the imported good is defined by the inverse demand curve (4).
Where and are constants defining our demand curve. Interaction between suppliers and final consumers takes place through the services of a domestic service sector that facilitates both the movement of imported goods inland and wholesale and retail distribution, marketing, and any ancillary services required to sell the goods. These services are supplied by a domestic service sector – modeled as a Cournot oligopoly at constant marginal cost.
The total revenue of a representative firm i in the service sector is:
where and are the quantity of imports sold by a representative intermediary firm
. We further assume that there are n identical firms in the service market, each having a share of sales. It proves useful to define the index as an index of market competitiveness that ranges from a value of 1 to 2. A value of implies perfect competition while maps to a single firm monopolizing distribution .
In equilibrium, we may also have where the service sector acts as a monopolist through perfect collusion in a cartel. Assuming a constant marginal cost c, profits of service firm are:
From the first-order conditions for profit maximization, quantities will be
The split between imported and domestically sourced q will depend on relative import and domestic supply conditions and the tariff rate .
2-Markups, Tariffs, and Importer Welfare
It is evident that service-sector firms have power on both sides of the market. Their profits are a function of manipulating double margins. On the input side, the price they pay for imports and domestic goods depends on the total quantity bought and the sensitivity of supply to quantity. Similarly, on the demand side, the price at which they sell to consumers is a function of total quantity brought to market. By restricting their trading, the firms are able to both drive down costs in both supply markets and drive up prices, widening the price-cost margin and boosting profits. The service-sector margins amount to:
Equations (10) and (11) lead directly to the following propositions.
Proposition1: The Cournot-Nash mark-up on imports for the domestic trade and distribution sectors is a decreasing function of the underlying import tariff.
Proposition2: The Cournot-Nash mark-up on domestic shipments for the domestic trade and distribution sectors is independent of the underlying import tariff.
The mark-up over marginal cost for imports declines directly with the tariff. Any attempt on the part of the government to exercise its monopoly power in trade eclipses the ability of the service sector to exercise its market power in the same market. What is the interaction between tariffs, market power, and the volume of trade? Differentiating equation (8) with respect to _ and _ yields the following:
This allows us to make the following propositions.
Proposition3: Despite the presence of an imperfectly competitive service sector, it remains the case that international trade volumes decline with increases in the import tariff.
Proposition4: International trade volumes are inversely related to the degree of concentration in the domestic trade and distribution sector, or alternatively the degree of market power exercised in the domestic distribution sector.
Proposition5: The negative impact of a marginal change in market power on trade volumes is greatest in a zero tariff context, and its marginal impact falls with increased levels of import protection or concentration. Hence, the largest impact of imperfect competition in the service sectors will be observed in zero-tariff countries, free-trade areas, customs unions, and under non-reciprocal trade preferences.
The model focus next on the welfare implications of a range of alternative tariff regimes for the importer, and the role played by service-sector competition across these possibilities.
Domestic welfare W is comprised of four elements: service sector profits , domestic upstream producer profits , consumer surplus CS, and tariff revenue TR. Thus:
An explicit expression for service-sector profits is obtained by combining equations (6), (7), and (8).
As both the service-sector profit margin and the volume of trade decline with the tariff, profits of intermediaries decline as the trade tax is increased. The economic profits of the upstream sector can be measured directly by the area between the domestic supply curve and its intersection with the domestic ex-factory price. Combining equations (3) and (7) yields equation (16).
Similarly, consumer surplus CS is simply the familiar triangle under the demand curve (4) and above the final demand price p. This is represented by equation (17).
Finally, tariff revenue follows directly from equation (8).
Combining equations (15), (16), (17), and (18) with equation (14) yields welfare.
If we then take the first-order conditions for welfare maximization, we can solve for the optimal tariff as a function of and the basic demand and supply coefficients of the model. This yields equation (19).
As would be expected, consumer surplus declines monotonically with an increasing tariff, while tariff revenue increases to a maximum and then falls. Consequently, for national welfare, there is an interior solution for the optimal tariff, indicated by . The loss to the service sector and consumers ( and CS) from an increasing tariff rate is more than offset to the left of the optimal tariff by the combination of rising domestic profits for upstream producers and tariff revenue TR, while it is only partially offset to the right of the optimal tariff line. The government, in exercising its monopoly power in trade, has the ability to limit the ability of the service sector to extract rents.
As has already been established, the profits of the service sector decline with the tariff.
Consequently when these rents accrue to domestic agents, the government will wish to moderate its use of the tariff. Indeed, viewed from the perspective of the optimal volume of imports the trade-off is complete. This can be seen by substituting equation (19) into equation (8), which yields equation (20).
From equation (20), we can see that from a welfare perspective optimal imports are independent of the degree of market power in the domestic service sector. The coefficient does not appear in equation (20). In exercising the optimal tariff, the government would seek to target the optimal volume of imports by adjusting the tariff rate to compensate for variations in service sector market power . As a result, the optimal tariff is a strictly decreasing function of the degree of market power in the service sector. This can be shown by differentiating equation (19) with respect to .
The sign of equation (21) is negative whenever .
With the additional distortion in the market, in the form of an imperfectly competitive distribution sector, the welfare implications of trade policy become more complicated. It is evident that the optimal tariff declines with increasing concentration in services, the optimal tariff when the service sector is a monopoly is a subsidy.
In the absence of such an optimal tariff offset by the government, the more concentrated the service sector, the greater its exercise of its market power and, consequently, the lower the trade volume. A tariff further reduces the volume of trade, whereas a subsidy increases the level of imports and hence consumption. Such a subsidy benefits the service sector but, as their profits are part of national welfare, a welfare maximizing government would be prepared to offer it. We summarize the relationship between tariffs, profits, trade, and welfare in the following propositions:
Proposition6: The optimum import tariff is a decreasing function of the degree of market power in the domestic trade and distribution sectors, and with a domestic service monopoly or cartel, the optimum tariff may actually be a subsidy.
Proposition7: There is scope for either the private service sector (through markups) or the government (through tariffs) to exercise market power in international trade, with the optimum tariff implying direct substitution.
3-Market Access and the Exporter
Consider the impact of alternative tariff and competition regimes for the exporter. If we are focused on quantity alone, then equations (8), (12) and (13) point to a negative relationship between tariffs and imperfect competition, on the one hand, and export volumes on the other. In addition, taking the cross-derivative from equation (13) we can see that the trade volume effect of a tariff reduction depends on the underlying trade volume and hence on the degree of competition in the domestic distribution sector. To some extent, tariff reductions may simply lead to a greater exercise of market power by the domestic distribution sector (and vice-versa), nullifying expected direct benefits from tariff reductions in export markets.
A second measure of the benefits of improved market access conditions is exporter producer surplus PS. Once again, this is simply the area of a triangle, in this instance the area between the inverse supply curve and the export price:
From equation (22) we can calculate the welfare benefit to exporters of improved market access as manifested through increases in export quantities as being simply:
Further manipulation then confirms that the PS benefit of tariff reductions is a decreasing function of the underlying market power of the service sector.
We summarize this section with the following propositions.
Proposition8: The market-access benefits of tariff reductions in export markets are inversely related to the degree of market power exercised by the domestic trade and distribution sector in the export market.
Proposition9: The benefits of market access concessions can be offset by increases in the degree of market power exercised by the domestic trade and distribution sector in the export market.
4-China interest in Africa
Trade between China and Africa has quadrupled since 2000 when trade between Africa and China totaled around US$10 billion. Just five years later it had increased to US$28 billion. China is now Africa’s third largest commercial partner after the United States and France, and the second largest exporter to Africa after France. Remarkably, Britain – as a former colonial power – has been left far behind by China.
The economic relationship between Africa and China can be divided into three sections: China’s drive for resources such as oil, minerals, and food; new export markets for its products; and new investment opportunities for Chinese companies. Exports from Africa to China are primarily commodities and oil, while African imports from China consist of manufactured goods such as industrial products, electrical equipment and machinery, textiles and household utensils.
Like the US, China is seeking new countries and different suppliers to fulfill its oil requirements in order to diversify its sources and achieve energy security. In Africa, where new reservoirs have recently been found, China has a every possible chance of success when it comes to exploiting new sources. To gain and retain control of these sources, it is allocating considerable military, politico-diplomatic and economic resources.
Africa owns around 8% of the world’s oil reserves and 11% of world oil production. It is estimated that production in Africa is rising 6% annually. By the and of 2007, it will reach seven million barrels a day and by 2010 this figure is estimated to be eight million. New deep-water oil discoveries have been made in the Gulf of Guinea, more specifically in Nigeria, Angola and Equatorial Guinea. Even though Africa is notorious for its political and economical challenges, international oil companies are continuing to invest in the continent. This is because Africa is economically attractive for foreign investors as good conditions are offered by African leaders and most of the oil is being found offshore which has advantageous for the loading of tankers and provides a degree of stability in oil production levels. African oil is also of high quality.
A quarter of China’s oil imports come from Africa: from Algeria, Angola, Chad, Sudan, Nigeria, Gabon and Equatorial Guinea. The thirst for oil is becoming so important that even the ‘One China Principle’ is being disregarded since Chad has diplomatic relations with Taiwan. A new pipeline from Chad to Cameroon opened in 2003 so that oil from Chad can be transported directly to a major port. Even though this trade in natural resources has a positive effect on the trade balance, it has some disadvantages as well. The production of oil merely requires capital investment and laborers are not required in large numbers. And in countries where oil is abundant, governments tend to focus on the wealth-generating oil sector and to neglect other sectors. Corruption is a frequent problem.
Another natural resource that China needs to import from Africa to support is own economic growth is timber. Until recently, the demand for timber was met by domestic lodgers. However in 1998, the Yangtze River overflowed resulting in 2,500 deaths and billions of dollars of damage. Following these floods, the Chinese government banned logging in large parts of China and has begun to protect its healthy forests and replant woodlands that had already been cleared for agriculture. These measures were taken to prevent further large-scale disasters, such as the 1998 floods. Internal pressure has forced China to import timber from other countries and imports of industrial wood have more than tripled since 1993. China is now importing considerable amounts of wood from the forests of Cameroon, Congo, Equatorial Guinea, Gabon and Liberia. In Cameroon, the exports from illegal logging amount to 50% of total exports of wood, and in Congo, Equatorial Guinea and Liberia the figure has raised to 90%. The types of wood that are being exported are not declared in national trade statistics, which makes it impossible to determine the actual imports of different kinds of timber. According to the Chinese Ministry of Foreign Affairs, the main exporting countries are Nigeria, the Central Africa Republic, Equatorial Guinea and Gabon.
China is the world’s leading exporter of textiles and clothing. In spite of its own domestic production, China still needs to import cotton, which it does from the US. However, the share of the African countries that export cotton – Burkina Faso, Benin, Mali, Guinea, Nigeria, Togo and the Central African Republic – has increased since the mid 1990s.