There are increasing worries about rising `market power’ of large corporations, both in the U.S.A. and across the globe. Powerful firms can reduce competition on many fronts. The usual worry is that insufficient competition harms consumers by pushing up prices and/or lowering product quality. A lack of competition can, however, also hurt workers if firms use their dominant position to lower prices paid for their inputs, such as labor or raw materials. When designing competition policy to ensure an even playing field, it is crucial to know where exactly firms exert their market power.
In his paper `Market Structure, Oligopsony Power, and Productivity’, Professor Michael Rubens investigates this question in the context of the Chinese tobacco industry. Industries that rely on agricultural products are generally vulnerable to the exertion of buyer power, because they often feature a limited set of final goods producers or processers who buy inputs from a large number of farmers. The main questions addressed are (i) whether Chinese cigarette firms mainly exert market power on cigarette or tobacco leaf markets, and (ii) how these different types of market power are affected by mergers and acquisitions.
- Why Chinese tobacco? When simply comparing input and product prices between merged and non-merged firms before and after mergers, there is a worry that there are unobserved drivers of both mergers and prices: mergers are the result of careful consideration by the involved parties. The Chinese tobacco industry offers a unique setting that circumvents this issue, because of a 2003 reform that consolidated the industry along strictly enforced size thresholds. In addition, local tobacco leaf markets in rural China are isolated due to legal restrictions on cross-county tobacco leaf trade. This allows to divide local tobacco markets into markets that are treated and untreated by the consolidation of the industry.
- What do I find? Combining this local market variation with a structural model of pricing and production, and using detailed firm-level data on all Chinese cigarette manufacturers between 1999 and 2006, I find that manufacturers do not have any pricing power on the cigarette market, but do have large market power when setting prices of tobacco leaf. I find that tobacco farmers receive merely a quarter of the price they would receive in a competitive market. Moreover, the industry reform lowered this share received by the farmers by another 30% on average.
- Why does this matter? Urban-rural income inequality is a large problem in China and in many other countries. The evidence in the paper shows that industry consolidation policies that are meant to increase firm productivity growth can lead to distortions on input markets, and hence to higher regional inequality by worsening the bargaining positions of farmers.