The Tip of the Iceberg: Actual Trade Flows Understate the Extent of Globalization

The United States and Brazil both have many local consumer markets which imported cement can access by waterway. Despite this similarity, the degree of import penetration is strikingly di¤erent. While imports from around the world account for as much as 30% of U.S. cement consumption, Brazil hardly imports cement. U.S. cement producers, facing lower inbound trade costs and higher marginal costs compared to their Brazilian counterparts, not only compete (on the margin) with foreign capacity but actually welcome it (on the inframargin) as an extension of their own capacity. This paper provides evidence to support that import competition in Brazil, though latent, is already present in the form of an entry threat which sets a price ceiling that binds on domestic outcomes. In explaining domestic prices, I show that mixture models that allow for an imports price ceiling outperform models where a foreign sector is absent. The unique institutional setting vividly illustrates how actual trade ‡ows may represent only the “tip of the iceberg”when it comes to inferring the extent of trade integration: only in the U.S. does one see imports, but the threat of foreign entry in Brazil already restricts the exercise of market power, if not entirely. Such latent international competition is not captured by traditional models of comparative advantage, and helps explain why product prices and wages appear to be increasingly determined by global forces of demand and supply. Keywords: Import competition; international competition; imports discipline; trade arbitrage; price ceiling; threat of entry; contestability; mixture models; nonnested model selection tests JEL classi…cation: Author’s correspondence details: Kellogg School of Management, Management and Strategy Department, 2001 Sheridan Road, Evanston, IL 60208, USA or email [email protected]. I thank Yongbae Lee and Natalia Szadkowski for superb research assistance. The usual disclaimer applies.