It is no secret that in many developing countries large foreign firms dominate the export market, giving them immense power to determine the prices at which a vast group of small exporting firms sell their goods.
On the surface, this would seem to be a mostly negative phenomenon. In a recent study I conducted, for example, I found that these large foreign buyers impose average markdowns, or price discounts, of around 26% and that exporters’ revenues could be significantly higher without them.
Large Foreign Firms Provide a Buffer Against Exchange Rate Shocks
But that is far from the whole story. Large, powerful buyers are also better able to handle exchange rate fluctuations and can modify the markdowns they impose on sellers during exchange rate shocks. That can reduce sellers’ exposure to exchange rate volatility, ensuring that demand for their product is maintained, and provide stability. The dominance of large foreign firms in a given market can thus generate a tradeoff: lower overall revenues in exchange for greater revenue consistency.
Consider the case of Starbucks’ in Colombia. As a powerful US-based purchaser of coffee, the company can get a higher markdown on the coffee it buys in Colombia than smaller U.S. importers, reducing revenues for Colombian coffee exporters. At the same time, if the Colombian peso were to depreciate, Starbucks could reduce the markdowns it imposes on sellers, helping to mitigate the shock and smooth out their earnings. Conversely, if the peso were to appreciate and the price of coffee were to rise, the big buyers could increase their markdowns to keep the price steady. That way, big buyers could continue purchasing coffee at the higher exchange rate to a much greater extent than small U.S. firms that might have to pack up and start buying their coffee from another country.
A Wide-Ranging Study in Colombia
This dynamic isn’t limited to coffee, of course. In my study I examined all types of Colombian exports to the world from 2007 to 2020 and found that in a phenomenon known as the exchange-rate pass through – the extent that sellers’ prices change in response to exchange rate fluctuations — price changes were much smaller for sellers that trade with large buyers than those that trade with small ones. Indeed, exporters that sell to large foreign firms changed their prices by an average of 1% of the shock’s magnitude as a result of exchange rate shifts, compared to an average of 15% for those that sold to small foreign firms.
Considering the Overall Benefits to Sellers in Export Markets
There is tradeoff, however, and it needs to be considered. The concentration of large foreign firms in a developing country can protect sellers in export markets from volatility. But it also creates dependency and allows those large buyers to dictate terms and suppress prices. Developing countries with less exchange rate volatility might well want to reign in that market power with laws and regulations that monitor and limit excessive buyer dominance. Governments could set price floors, protecting exporters by imposing minimum prices for their goods. They could push forward policies that encourage transparency in pricing practices and help smaller exporters negotiate more favorable terms with large foreign firms. And they could consider how mergers and acquisitions might further entrench the power of large buyers, potentially leading to even greater market concentration. Finally, they might pursue more trade partnerships across different regions, giving exporters more bargaining power through a different channel. Today, more than 83% of U.S. imports are in the hands of the top one percent of importers, a group with outsized power to affect prices and price dynamics in export markets. This gives them the ability to impose, and adjust, markdowns: to reduce revenues while also protecting sellers from exchange rate volatility. But it can also amount to too much influence and control, and it is up to governments to decide in that delicate market tradeoff what measures can both increase the incomes of small and large exporters and ensure them at least some stability.
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