How does the vertical structure of an industry affect the links between cross-border mergers and international trade? To answer this question, we construct a tractable vertical general equilibrium (VGOLE) model of an oligopolistic industry. In a vertically related industry, firms are located at different stages of production or distribution, with some firms supplying inputs used by others. Mergers in vertically related industries have been drawing increasing attention of regulators, anti-trust authorities, as well as those in the media and academics. This is so because cross-border mergers between firms in such industries add more complexities for competition within and across open economies.
Although the theoretical literature on cross-border mergers is still at its infancy, to the best of our knowledge, our VGOLE construct is the first general equilibrium model to explore the implications of vertical structures for the links between cross-border mergers and international trade in oligopolistic industries. The vertical structure of an industry injects a distinction between the foreign and domestic firms, even in the absence of transport costs, because mergers can affect competition in input markets creating, in addition to the usual market power motive, an input-market concentration effect. Our key results, stemming from a direct comparison of the pattern of specialization and the incentives for cross-border mergers with and without the possibility of vertically integration, are that a) the extensive margin of trade shrinks in the face of vertical integration; and b) cross-border mergers mitigate the effect of vertical integration on the extensive margins of trade by facilitating specialization toward the direction of comparative advantage. Intuitively, as the disintegrated home firms become less competitive, it allows foreign firms to compete in a larger subset of sectors, wherein, without vertical integration, home would have a comparative advantage. The impact of a merger, on the extensive margins of trade, is magnified when the merger takes place between two disintegrated firms across borders compared to a merger between a disintegrated firm in one country and a vertically integrated firm in another.
The rest of the chapter is organized as follows. In the next section, we present our VGOLE model and results. In the third section, we discuss the welfare implications of our construct and cover some caveats. In the final section, we draw key conclusions.