Do Prices Determine Vertical Integration? Evidence from Trade Policy
Harvard University - Business, Government and the International Economy Unit
Centre for Economic Policy Research (CEPR); Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES)
University of Vienna
Andrew F. Newman
Boston University - Department of Economics
May 24, 2013
Harvard Business School BGIE Unit Working Paper No. 10-060
What is the relationship between product prices and vertical integration? While the literature has focused on how integration affects prices, this paper shows that prices can affect integration. Many theories in organizational economics and industrial organization posit that integration, while costly, increases productivity. If true, it follows from firms' maximizing behavior that higher prices cause firms to choose more integration. The reason is that at low prices, increases in revenue resulting from enhanced productivity are too small to justify the cost, whereas at higher prices, the revenue benefit exceeds the cost. Trade policy provides a source of exogenous price variation to assess the validity of this prediction: higher tariffs should lead to higher prices and therefore to more integration. We construct firm-level indices of vertical integration for a large set of countries and industries and exploit cross-section and time-series variation in import tariffs to examine their impact on firm boundaries. Our empirical results provide strong support for the view that output prices are a key determinant of vertical integration.
Number of Pages in PDF File: 44
Keywords: Theory of the firm, vertical integration, product prices
JEL Classification: D2, L2working papers series
Date posted: June 16, 2010 ; Last revised: May 24, 2013
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