Import competition and domestic vertical integration: Theory and Evidence from Chinese firms

TL;DR

This paper investigates how import competition influences Chinese firms' vertical integration decisions, revealing that tariff reductions promote integration especially in high-tech and asset-specific industries, based on empirical analysis.

Contribution

It develops a theoretical model and provides empirical evidence on the impact of import tariffs on domestic vertical integration in Chinese firms, highlighting mechanisms like asset specificity and technology.

Findings

Tariff reductions increase vertical integration.

Asset-specific industries show stronger effects.

High-tech firms respond more to import competition.

Abstract

What impact does import competition have on firms' production organizational choices? Existing literature has predominantly focused on the relationship between import competition and firms' global production networks, with less attention given to domestic. We first develop a Nash-bargaining model to guide our empirical analysis, then utilize tariff changes as an exogenous shock to test our theoretical hypotheses using a database of Chinese listed firms from 2000 to 2023. Our findings indicate that a decrease in downstream tariffs lead to an increase in vertical integration. In our mechanism tests, we discover that a reduction in upstream tariffs also enhances this effect. Moreover, the impact of tariff reductions on vertical integration is primarily observed in industries with high asset specificity, indicating that asset-specificity is a crucial mechanism. We further explore whether import competition encourages vertical integration for technological acquisition purpose, the effect is found only among high-tech firms, while it's absent in non-high-tech firms. Our research provides new perspectives and evidence on how firms optimize their production organization in the process of globalization.