Trade reforms, mark-ups and bargaining power of workers: the case of Ethiopian manufacturing firms

Abstract

There is a predominant preposition in trade theory that firms operating in an imperfect market with trade barriers often set prices with a positive mark-up. Workers using insider information tend to bargain and share the rent from firms’ market power; which is negatively associated with to decline with trade reforms. Empirical evidences are, nonetheless, mixed. Trade reforms that took place between 1991 and 2002 in Ethiopia inspired the study to investigate the proposition. Using firm level unbalanced data of manufacturing firms employing more than 100 permanent workers between 1996 and 2007, a model of mark-up with labor bargaining power was estimated using random effects and LDPDM. The estimates of the two models are similar. Albeit huge inter-firm variations, the average estimated mark-ups has not only been positive but also increased even after the reform. This may be perhaps because of the 17.5 percent weighted average tariff rate that has still been maintained after the reform. Workers’ bargaining power parameter estimate remained negative over the study period; possibly because of high unemployment and low reservation wage. The rate of rent extraction from workers declined on average in the post reform period. Thus, further opening up of markets may bring a competitive push to improve firm performance, reduce market power of firms and the rent extraction from workers. There is a need to attract additional investment (both public and private) in the economy and addressing causes of capacity underutilization of incumbent firms may lessen unemployment problems and thereby improve workers bargaining power and their earnings.

Keywords: Trade reform, mark-up, bargaining power, rent, trade unions