Supplier preferences and dumping: an analysis of Japanese corporate groups.

• Author: Cheng, Leonard K.

1. Introduction

   While the nature and intensity of issues confronting the international economy change over time, the trade and investment tensions between the U.S. and Japan have continued unabated for many years. In part they find their origin in Japan's overall and bilateral trade surpluses, although these are generally recognized as macroeconomic phenomena. Apart from the trade imbalances, bilateral disputes arise also from the perceived inability of American exporters and investors to penetrate the Japanese market. There is empirical evidence indicating that the Japanese firms have a distinct preference to buy their needed machinery and other inputs from other Japanese firms [5; 6; 7]. It is the closed nature of Japan's market that triggered the bilateral negotiations known as Structural Impediments Initiative.

   One reason for the difficulty faced by outsiders trying to sell in Japan is the way in which Japanese companies are organized. Keiretsu is a form of interlocking relationships among Japanese firms and industry groups [2] that allegedly enjoys advantages such as risk-sharing and stable inter-firm relations (which encourage efficient investment in relation-specific assets) and oligopolistic market power.(1) It has been suggested as a possible reason for low sales by non-Japanese firms to Japanese firms operating inside and outside of Japan. There is certainly a strong tendency for member companies of a Keiretsu to source from within their own corporate group.

   This paper explores an economic rationale for this behavior by examining the implications of cross ownership and implicit contracts (long-term reciprocity), and shows that supplier preferences unambiguously increase the incidence of dumping. In this fashion the paper provides a link between two sets of stylized facts: supplier preferences by Japanese firms, and the numerous dumping complaints brought in the US. against large Japanese companies. Supplier preferences also increase the profits of firms which are directly involved in the arrangement, albeit at the expense of outside firms, and lead to lower prices for consumers.

   In the next section we examine three models of supplier preferences that are based on cross ownership and implicit contracts. Alternative explanations of supplier preferences are provided in section III, while the effect of supplier preferences on dumping is analyzed in section IV and their implication for profits and consumer welfare are explored in section V. The final section summarizes our conclusions.

2. Models of Supplier Preferences

   Consider three firms, A, B, and D, where A and B are Japanese firms which have cross ownership or an understanding of mutual reciprocity, while firm D is a non-Japanese firm not involved in any arrangement with A or B. From an analytical point of view, the national identity of these firms is not important. What is important is that A and B belong to some "alliance" either through cross ownership or the establishment of a long-term reciprocal relationship, but D is not part of that alliance.

   In the following subsections we examine three models which generate rational supplier preferences.(2) The first model of unilateral cross ownership, which features a vertical production relationship between A and B, is a building block of the second model of bilateral cross ownership, which features a "symbiotic" or two-way production relationship between the firms. In contrast with some recent work which underscores the incentive of an integrated firm to set a high price for the export of an intermediate input to its foreign downstream competitor [10; 11; 12], our models attempt to explain why a downstream Japanese firm chooses to buy an intermediate input from an upstream Japanese firm when the former has the option of buying the same input from a non-Japanese firm at a lower price. The third model shows that A and B may give each other's products preferential treatment even without cross ownership. This result is consistent with the finding that cross ownership is only one of the factors which bind firms in a Keiretsu together [3].

   This paper does not seek to explain the existence of Japanese corporate groups, but instead examines their implications for supplier preferences and dumping.

   Supplier Preference under Unilateral Cross Ownership(3)

   Let y be the quantity of A's sales, taken to be a function of its price p. To produce y, A requires a homogeneous input which is produced by both B and D. Let q be the price charged by B and [q.sup.*] be the price charged by D for this input and let the quantities of purchases from them be denoted by x and z, respectively. Throughout the rest of this paper, an asterisk signifies prices charged by the "outside" firm D. While it would be interesting to model explicitly the strategic interaction between B and D, for our purposes we simply assume that q and [q.sup.*] are oligopolistic prices which exceed the firms' respective marginal costs.

   The cost of producing y besides this particular input is denoted by c(y; x + z). Suppose [Alpha](0 [less than] [Alpha]1) of B's shares are owned by A, then A's own profit plus its share of the part of B's profit which depends on A's input purchase decision are given by

   [[Pi].sup.A] [equivalent to] py(p) - qx - [q.sup.*]z - c(y; x + z) + [Alpha][qx - g(x)], (1)

   where g(x) is the additional costs to B of producing x, and [qx - g(x)] is the additional profits that B will make if A buys x of the input from B. The part of B's profit which is unrelated to A's purchase decision is left out as it will not affect the analysis.

   Since B and D produce a homogeneous input, the choice between them depends only on the relative magnitude of [q.sup.*] and [q.sub.e] [equivalent to] [q - [Alpha](q - g[prime](x))], where [q.sub.e] is the "effective" price of the input supplied by B. More specifically, A buys only from B if the effective price of x, [q.sub.e], is lower than that of z, [q.sup.*]. In other words, if the excess price charged by B is smaller...