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Forthcoming in the Journal of International Economics. We thank three referees and Robert Feenstra for helpful comments as well as Simon Anderson, Bill Francis, Chris Milner, and seminar participants at the University of Nottingham. The usual disclaimer applies. This paper was written when D.M. Gross was a member of RIIM and the Department of Economics at Simon Fraser University and when the authors were visiting the University of Virginia, EPRU at the Copenhagen Business School, and the University of Geneva. These institutions are thanked for their hospitality.
Mr. Schmitt is Associate Professor, Department of Economics, Simon Fraser University, Burnaby, Canada.
At the firm level, in 1990, more than 50 percent of all new registrations of passenger cars in Switzerland have been supplied by five producers only, all in our sample of countries: Opel, VW, Toyota, Ford, Peugeot and Renault (MWMA of US, 1992, p. 238). This percentage may underestimate the concentration ratio within different categories of automobiles. For studies of firms’ behavior in the automobile industry, see Bresnahan (1981), and Mertens and Ginsburgh (1985).
For instance, limited capacity of production or distribution, adjustment costs in production or in prices such as when contracts exist between producers and retailers (menu costs), or else sunk investments. Limited capacity of distribution does not seem to be a major constraint since most producing firms are also wholesalers on the Swiss market.
Own exchange rate is an element of this vector since costs are in the seller currency while
This assumption is consistent with imperfect capital mobility (see Froot and Klemperer, 1989). Alternatively, the uncovered interest parity condition coupled with the hypothesis introduced later that the exchange rates follow a random walk also lead to
Tivig (1996) shows this is the case in a Hotelling model and thus, in a model where demand for a product depends on the price difference between imperfect substitutes. This is a reasonable representation of a mature market like the automobile market since it implies that no firm can increase its market share without decreasing its rival’s share.
Klemperer (1995) argues that, because of the incentive to exploit old customers, the presence of switching costs increases the equilibrium prices with respect to the equilibrium without switching costs.
The classification of automobiles changed at the end of 1976 and earlier series are not consistent with the new definitions.
Until 1987, the tariffs per 100 kilograms for non-EC/EFTA automobiles were SFr96 or less and for EC/EFT A automobiles, SFr81. After 1987, there was no tariff on EC/EFTA automobiles and a uniform per-unit tariff of SFr81 for non EC/EFTA automobiles (Statistique Mensuelle du Commerce Extérieur de la Suisse, Direction Générale des Douanes, Bern). The change in tariffs has been shown to have no significant impact on the pricing strategy (Gross and Schmitt, 1996).
In our trade statistics, the source country is the country of production and, in addition to the well known brand names, Germany is the source country for Opel (GM Europe). Ford’s production originates either from Germany or from Belgium (Commission of the EC, 1983, p. 61).
Information on the total values and number of units are from the Statistique Mensuelle du Commerce Extérieur de la Suisse, Direction Générale des Douanes, Bern.
Labor compensation is the largest component of value-added in the two-digit level industry including automobile production in all countries. In 1983, for our countries, it was between 62 percent and 80 percent of added-value and in 1991, between 56 percent and 76 percent (National Accounts Statistics. Main Aggregates and Detailed Tables. United Nations. New-York). In Germany and in France, for the automobile industry alone labor compensation represented approximately 76 percent on average between 1983 and 1989 (Williams et al., 1994, Table 9.7).
Gagnon and Knetter (1995), for example, can exploit the time-series and cross-sectional dimensions of their panel to estimate costs as the common component in prices charged by one source country to several destination markets for a given product.
In 1988, for example, total exports of German automobiles to Switzerland represented 2.9 percent of total production. For France and Japan they represented 1.4 percent and 1.2 percent respectively. (Automobile Revue, Special annual issue published on the occasion of the 64th International Geneva Motor Show. Hallwag, Bern. 1990). Goldberg and Knetter (1997) rightly points out that costs might be endogenous to price in the case of larger markets.
The costs series are from Main Economic Indicators, Organisation for Economic Cooperation and Development, Paris. The exchange rate series are from the Bulletin Mensuel, Swiss National Bank, Zurich.
As the number of variables is large (12 in each category of automobiles), we follow Johansen (1992a, 1992b) who shows that the full model can be divided into a conditional model and a marginal model where weak exogeneity becomes a linear restriction on the marginal model. The test is then an F-test in the marginal model such that the coefficient on the cointegrating vector identified by the reduced-rank analysis is zero.
These tests, like unit-root tests, have low power in small samples and it is recommended to use 10 percent significance level (see Dickey and Rossana, 1994, Section IIIB).
We used the Engle-Granger (1987) procedure to test for cointegration in pairs of prices. The results of the cointegration tests are, for the medium-size/small-size automobiles, t(D, J)= -4.39/-2.40, t(D, B)=-3.09/-2.0, t(D, F)=-2.49/-4.0, t(J, B)=-3.58/-2.55, t(J, F)=-2.40/-2.28, t(B, F)=-3.24/-3.20. The critical value at 5 percent is t=-1.95.
The relevance of the German-Belgium cross-effect (as opposed to other country combinations) is supported by evidence on the ratio of the value of foreign vs domestic parts in each automobile. For examples, in 1979, the ratio of German parts in a French automobile was only 9.3 percent but it was 106 percent in a Belgian automobile. The ratio of French parts in a German automobile was 6.2 percent (own calculations from Commission of the EC, 1983, p. 120 ff.).
The other cointegrating vectors are constrained to have zero coefficients. This does not appear to be in violation to the unrestricted specification since their respective weights in the first-step are all very small.
More specifically, the Belgian pricing equation becomes,
Price and weight for each model are given in Automobile Revue, Special annual issue published on the occasion of the 64th International Geneva Motor Show. Hallwag, Bern. March, 1988.
The average unit-values, in Swiss Francs, over the sample are the following: For small-size automobiles PB=12,996, PF=11,154, PG=14,182, PJ=10,176 and for medium-size automobiles, PB=19,308, PF=18,968, PG=26,971, PJ=15,815.