The Market Structure Benefits of Trade and Investment Liberalization

This Working Paper develops a simple method for calculating welfare benefits when the market structure is made more competitive through the removal of import barriers and investment restrictions. Classic instances where trade and investment restrictions serve to preserve monopolistic monopoly market structures in a number of countries include automobiles, petrochemicals, telecommunications, insurance, and civil aviation. The analytic framework set forth in this working paper will be used in studies now underway of the cost of protection in Australia, Canada, China, the European Union and Indonesia.

For simplicity, the diagrammatic analysis is carried out as if the domestic industry acted like a pure monopoly (or perfect cartel); intermediate cases of monopolistic competition are not illustrated in graphic terms. In the mathematical section, and the numerical calculations, however, intermediate cases are considered.

At the conclusion of this chapter, we present numerical examples of four starting and ending market structures: monopoly (or cartel), four-firm monopolistic competition, eight-firm monopolistic competition, and perfect competition. We assume that, when trade and investment liberalization exerts an impact on market structure, it makes markets more competitive. For example, a monopolized (or cartelized) industry might instead act like four-firm monopolistic industry, or a four-firm monopolistic industry might be transformed into an eight-firm monopolistic industry.

Trade restrictions could take the form of tariffs, import quotas, or buy-national procurement policies; investment restrictions could keep foreign firms from opening (or expanding) their industrial and distribution outlets. When the government dismantles its trade and investment restrictions, foreign competition can help make the market structure more competitive. Transformation of the market structure, if it occurs, yields additional benefits on top of the static efficiency gains from trade liberalization calculated in Measuring the Costs of Protection in the United States.