Energy Trade Access and Market Monopoly: Evidence from China’s Power Sector

Abstract

We theoretically and empirically investigate the effect of energy trade access on the monopoly power of China’s power sector. We construct plant-level import and export tariff shocks, and calculate the market power markups through the joint estimation of the restricted cost function and the inverse supply relation. Exploiting the variations in plant-level tariffs, we find that a 1% cut in energy import tariffs leads to a decrease in market power markups by 10.54%. This effect is driven by a combination of a price drop in the product market and reduced marginal cost in the input market. However, the declines in marginal cost are small relative to the falls in prices, due to trade-induced increases in capital demand (and price) partially offsetting the savings in energy cost. By identifying additional potential channels, we validate the presence of the classical Ricardian effect and the Schumpeterian effect. Our results demonstrate that import tariff reductions result in substantial net trade gains.