Imposing trade restrictions on parallel imports can motivate a firm to export, study finds

April 11, 2012 By Margaret Allen, Southern Methodist University

( -- Imposing trade restrictions on parallel imports has the surprising effect of motivating a firm to export, according to a new study using game theory economic analysis.

Economists Santanu Roy, Southern Methodist University, Dallas, and Kamal Saggi, Vanderbilt University, Nashville, found that diverse parallel importing policies among countries today make it possible to analyze for the first time how competition between firms and allowing or banning parallel imports can influence competition in foreign and domestic markets.

“Our research is the first to look at the consequence of strategic policy setting by governments in the context of competition in domestic and foreign markets,” Roy said.

Most surprising among the findings, he said, is that imposing trade restrictions on parallel imports can actually motivate a firm to export — when the market to which it is exporting is smaller than its own.

“So even though you are formally prohibiting the import of a product, you are actually promoting trade,” Roy said. “And that’s a new way of looking at this.”

Parallel importing: When a firm competes with itself

Parallel importing occurs when a manufacturer exports its trademarked or patented products to a foreign market where demand, policies or price pressures require the goods be sold at a lower price. A third-party buyer purchases the low-priced goods and imports them back to the manufacturer’s home country, undercutting domestic prices.

The controversial practice has spawned gray market retail, where consumers buy high-value, brand-named goods at cut prices, such as electronics, video games, alcohol, books and pharmaceuticals.

Parallel importing and gray market retail are growing worldwide

Some advocates of free trade decry parallel importing, saying it infringes on manufacturers’ intellectual property rights accorded by copyright, patent and trademark laws. That, in turn, can discourage investment in new technology and products.

As a result, some countries allow parallel importing; others ban it. For example, parallel importing is allowed among the member countries of the European Union. It’s not permitted by the United States, although exceptions exist for many different products. Generally speaking, developed nations restrict parallel importing, while developing nations allow it.

The study by Roy and Saggi found there is no one-size-fits-all solution — neither a global ban nor a blanket endorsement.

Only need for intervention could be countries with major asymmetries

In fact, the study’s authors found that policy diversity is working well because it takes into account important variables such as similarity or dissimilarity of markets, as well as competing products and government regulations.

“The only area where there may be need for intervention is where there may be major asymmetries between countries — where one country is very large and the other is very small,” Roy said.

Roy and Saggi found that there’s strategic interdependence in the policymaking across governments, as well as a lot of strategic dependence in the decisions of firms. For that reason, the degree of asymmetry of demand across countries is going to be a very important part of the picture, Roy said.

Impact of parallel importing varies, depending on the markets

By modeling the impact of parallel importing under various scenarios, Roy and Saggi discovered that parallel importing typically works in favor of a domestic manufacturer whose export market is similar in size to its domestic market, and where intellectual property rights and parallel trade policies are similar to its own. In that case, a competitor is unlikely to cut prices, and prices remain stable and profitable both at home and abroad.

However, where markets are dissimilar, they found that parallel importing led to price slashing both at home and abroad, which in turn drove manufacturers to abandon exporting to prevent prices being slashed at home.

“One of the consequences of parallel import policy is that when it’s allowed, firms will actually take steps to alter their pricing in such a way that parallel imports don’t occur,” Roy said. “So the fact we don’t actually observe parallel imports in data doesn’t mean that parallel import policy does not have a very important impact on the way firms price their goods across the markets.”

Parallel importing policies should be set on a case-by-case basis

Because the impact of parallel importing varies on a case-by-case basis, policies governing parallel imports should be determined country by country and product by product. Roy and Saggi warn against uniform global standards to restrict or allow parallel imports, such as could be imposed by the international trade governing body, the World Trade Organization, or through its agreements, such as the TRIPS agreement on trade-related intellectual property rights.

Roy and Saggi report their findings in two articles: “Equilibrium Parallel Import Policies and International Market Structure,” a scenario in which there are quality differences in the products across countries, forthcoming in the Journal of International Economics; and “Strategic Competition and Optimal Parallel Import Policy,” a scenario in which there’s asymmetrical protection of intellectual property, forthcoming in the Canadian Journal of Economics. Roy and Saggi were members of a development research group at the World Bank that researched parallel importing.

Roy is professor and director of graduate studies in the SMU Department of Economics. Saggi is professor and director of the graduate program in economic development in the Vanderbilt Department of Economics.

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