On Predatory Pricing

China is in the news for (among other things) devaluaing their currency, the Renminbi (RMB, or Yuan).  This has lead to a return of mercantalist fears about China, including that they are devaluing their currency and subsidizing exports in order to harm America and undercut our industry by selling their goods well below market price.  This is called predatory pricing.

The idea behind predatory pricing is this: An economic actor enters a market and sells at such a low price that they take losses.  With their lower prices, they drive out all competition and effectively create a monopoly.  Then, using their monopoly power, they raise prices above the market level in order to gain extra-normal profits.

The problem with this argument is that it assumes a dynamic market up to the entry of the predatory pricer, and then a static market thereafter.  Absent artificial barriers to entry in this market, when the predatory pricer raises their prices to extra-normal levels, it would create opportunities for new firms to enter the market at a lower price point, and thus erode the predatory pricer’s extra-normal profits.  In order to regain their advantage, they would need to cut prices down again.  In other words, in order to maintain their advantage, a predatory pricer would need to constantly take losses, which negates the whole point of entry.

To be fair, this strategy can work in the short term.  It is currently being employed by both the Saudi Arabians and US oil miners to maintain/grab market share in the oil market (much to the benefit of oil consumers everywhere).  But one can only absorb losses for so long.  Eventually, he’d have to adjust and create efficiencies to operate profitably at the new level.

As with most fears regarding China, the predatory pricing one is largely unfounded.  Ultimately, the one being hurt the most is not the US but rather China and its citizens.

4 thoughts on “On Predatory Pricing

  1. In addition, the predatory pricer is almost certainly the largest actor in that market and is already operating on the lowest margins. Where’s the war chest to cover the losses?

    The only natural monopoly I’ve ever heard of is the De Beers Group.

    Like

  2. Jon,
    There is one feature of subsidizing I never hear being challenged by us.
    It isn’t every industry that governments want to subsidize. Only new industries and even then only the new ones that survive infant mortality. What they don’t want to let happen is a foreign Silicon Valley (of some new technology). When a technology is mature, there are regions where all the subordinate factories to a new technology seem to have gathered. The important observation about that, is that the main factories and all the subcontracting factories are born at the same time in the same geographical area.
    I suspect that the maturity of solar cells is well into the asymptote where new money saving processes are glacial compared to 10 years ago. It is no longer an infant industry. We don’t make solar panels of economic significance and I suspect those of the left claims that the reason is that the thousand of subcontracting factories that support the solar panel factories are already established in the province of Jiangsu thanks to the early lead the Chinese government created.

    Like

  3. From dealing with both China and the US on a daily basis, I’ve found that both have severe unfounded fears about each other that they wish to portray through the media.

    My only fear is this: Friendly competition helps the free market, where as rivals guided by mistrust tend to bring everyone down with them.

    How will it end If both the US and China are going down the path of mistrust?

    Like

  4. “The phrase ‘unfettered trade’ is used for justification for government intervention in trade, but the argument is a red herring; a false representation of market forces.”

    Bigger government advocates always have to make stuff up because facts and reason seldom support their view.

    Like

Comments are closed.