Comparative advantage as a source of exporters’ pricing power: Evidence from China and India

The literature on ERPT has not considered product-level comparative advantage (CA) as a source of heterogeneous firm productivity. However, a firm’s production choice may determine its productivity level and also its pricing decision as both the degree of market power and the fixed costs of exporting vary across products. This paper empirically analyses the export pricing behaviour of Chinese and Indian exporters in 1994-2007 while considering 6-digit product-level CA at the intercept and at the slope. Previous ERPT estimates that did not take product-level CA into account are biased as CA is significant in both cases. ERPT is more incomplete in high CA products but export prices increase with export specialization because a stronger presence in export markets allows higher market power. With the REER, ERPT becomes zero as relative prices offset depreciation. If China were to let its currency float, Chinese exporters’ pricing strategy would become a classical case of incomplete ERPT. On the contrary, Indian exporters’ pricing strategy remains robust regardless of the exchange rate regime. This result supports recent calls for the adoption of a flexible exchange rate regime, particularly in the case of China.