The welfare effects of trade liberalization and exchange rate pass-through: Evidence from the car industry in Colombia

This dissertation empirically studies the welfare effects of trade reforms and exchange rate pass-through focusing on the specific case of the Colombian auto industry. Using product level data, I concentrate first on how firms' performance and consumers' welfare change due to the tariff reduction. Prior to the trade liberalization reforms imported cars had prohibitively high tariffs, on average 200%, and were essentially unavailable. After the reforms tariffs were reduced to 38% on average and foreign cars began to compete in the market. My findings show that prior to the liberalization process price-cost margins were already falling because of an ongoing reorganization within the industry. Confirming previous findings in the literature, once the reforms were implemented, margins fall reaching a low 23% for domestic cars. The behavior of price-cost margins is explained by increasing domestic competition prior to the reforms, the associated decrease in costs after the reforms and the relatively unchanged market structure. On the consumers' side, I estimate the monetary gains due to the liberalization process to be, as a consequence of declining prices and increased variety, over three thousand dollars per purchaser. A counterfactual exercise, where it is assumed that following the reforms no foreign cars entered the market, suggests that the gains achieved by consumers are due, for the most part, to increased variety rather than to price competition. Second, making use of a structural model, I find evidence that prices do not respond proportionately to exchange rates (incomplete pass-through). Using data for the post-reform period, in order to take into account both domestic and foreign cars, I find that the exchange rate pass-through is, as predicted, less than one, around 0.63 for imported cars and 0.43 for domestic cars. I explore the effects on the pass-through under different simulated market structure scenarios. The simulation suggests that a higher degree of market power allows firms to isolate themselves from foreign induced changes in marginal costs and therefore from exchange rate volatility. Finally, there is evidence that source market effects are important for pass-through in the automobile industry.