Market power, scale economy and productivity: the case of China’s food and tobacco industry

The purpose of this paper is to measure and examine the relationships between market power, scale economy and productivity for several important food and tobacco industries in China.

The model applied in this paper is based on Hall’s framework (Hall, 1988, 1990) and Klette (1999). The paper relaxes the assumption of constant returns to scale, and estimates market power and rate of returns to scale simultaneously, and then employs a covariance approach to examine the relationship between market power, scale economy and productivity via an unbalanced panel data at firm level.

Empirical results indicate that all the selected seven food industries are characterized with significant market power, especially for China’s cigarette industry whose markup is as almost five times as the smallest one. In addition, China’s soybean and cigarette sectors are manifested to have scale economy, with return to scale being larger than 1, while the other five sectors are proved to have decreasing returns to scale. Empirical results also provide evidence to support significant negative correlations between market power and scale economy in all sectors, and negative correlations between market power and productivity in most of the selected sectors. While more heterogeneous relationship between scale economy and productivity are found across the selected sectors.

This paper contributes to examine the relationship between market power, scale economy and productivity empirically for Chinese food manufacturers using a firm-level unbalanced panel data. Results which coincide well with the reality provide policy implication on understanding the situation of market structure for China’s food and tobacco industry.