Recent theoretical contributions provide conflicting predictions about the effects of product market competition on firms’ organizational choices. This paper uses a rich firm-product-level panel data set of Indian manufacturing firms to analyze the relationship between import competition and vertical integration. Exploiting exogenous variation from changes in India’s trade policy, we find that foreign competition, induced by falling output tariffs, increases backward vertical integration by domestic firms. The effects are concentrated among firms with high productivity and in industries with relatively low initial levels of competition. In contrast, falling input tariffs seem to have countervailing effects on vertical integration incentives. We also provide evidence that vertical integration is associated with lower marginal costs and increasing markups at the firm-product level.
Import competition and vertical integration: Evidence from India☆