Qing Liu, Larry D. Qiu, Chaoqun Zhan
In: Journal of International Economics, 2019, Vol. 121
In this study Liu et al. examine the effects of trade liberalization on domestic backward vertical integration in which a domestic upstream firm (target) is acquired by a domestic downstream firm. They first build a relationship-specific investment model to guide and provide insights to our empirical work. Then they take China’s accession to the WTO as a quasi-natural experiment for trade liberalization to test the theoretical predictions. Consistent with the model, they find that a decrease in tariffs on the target industry’s outputs reduces vertical integrations, but a decrease in tariffs on the target industry’s inputs increases vertical integrations. The findings are robust to various specifications of the empirical model and measurements of the variables. They further show that underinvestment problem is an important mechanism to understanding the effects of tariff reductions on firms’ organizational choices.