Journal of the Japanese and International Economies 13, 424–450 (1999)

Article ID jjie.1999.0430, available online at http://www.idealibrary.com on

Determinants of Individual-Firm Markup in Japan: Market

Concentration, Market Share, and FTC Regulations∗

Kenn Ariga

Institute of Economic Research, Kyoto University, Yoshida-Honmachi, Sakyo-ku,

Kyoto 606-8501, Japan
E-mail: ariga@kier.kyoto-u.ac.jp

Yasushi Ohkusa

Institute for Social and Economic Research, Osaka University

and

Kiyohiko G. Nishimura

Faculty of Economics, University of Tokyo

Received February 7, 1999; revised July 13, 1999

Ariga, Kenn, Ohkusa, Yasushi, and Nishimura, Kiyohiko G.—Determinants of Individual-

Firm Markup in Japan: Market Concentration, Market Share, and FTC Regulations
This paper estimates individual firm level markup for more than 400 major manufacturing
firms in Japan. Our estimates suggest the presence of significant market power for most of
these firms, due not only to market concentration but also to the firms’ own market shares,
as well as advertizing and sales promotion efforts. The paper then goes on to assess system-
atically the impact on estimated markups of regulatory measures taken by the Fair Trade
Commission (FTC) of the Japanese Government. We find that non-punitive FTC activities
are directed toward the right targets and are reasonably effective, whereas injunctions, the
strongest measure endowed to the FTC, has essentially no effect on the markups of firms
in our sample. J. Japan. Int. Econ., Dec. 1999, 13(4), pp. 424–450. Institute of Economic
Research, Kyoto University, Yoshida-Honmachi, Sakyo-ku, Kyoto 606-8501, Japan; In-
stitute for Social and Economic Research, Osaka University; and Faculty of Economics,
University of Tokyo. °c 1999 Academic Press

Journal of Economic Literature Classification Numbers: L13, L41.

∗ An earlier version of the paper was presented at the NBER-CEPR-TCER Conference on Competi-

tion Policy, December 18–19, 1998, International House, Tokyo, Japan. We benefited from comments
by Professors Tim Bresnahan and Noriyuki Yanagawa and other participants of the conference. The
research reported here is partially supported by a Grant-in-Aid from the Ministry of Education.
424

0889-1583/99 $30.00
Copyright ° c 1999 by Academic Press
All rights of reproduction in any form reserved.
 INDIVIDUAL-FIRM MARKUP IN JAPAN 425
1. INTRODUCTION

For most economists, in and outside of Japan, competition policy in Japan is

largely a neglected cousin of Japan’s industrial policy. Although the Japanese
government in recent years has made some attempts to place more emphasis on
the enforcement of anti-monopoly laws, the Fair Trade Commission (FTC), an
independent (administrative) body of the government, is tiny, seriously under-
manned, reportedly weak in political power, and largely neglected, at least until
quite recently.
The lack of resources is not limited to the government. There has been little
systematic research on the overall competitiveness of Japanese markets that is
comparable and consistent with the research on the United States and Europe.1
Among other things, in spite of its obvious importance, we know very little about
the overall magnitude, cross-section distribution, and temporal variations of price
markups in Japan.2
This paper attempts to fill this gaping hole in empirical studies of Japanese
markets and, in particular, of the pricing behavior of firms. We employ the estima-
tion procedure developed in Nishimura et al. (1999) (hereafter NOA)3 to obtain
estimates of individual firm markup over marginal cost4 for roughly 450 major
manufacturing firms5 located in 130 four-digit industries.6 The average estimated
markup of these firms is 1.29, and roughly 90% of the sample firms have markups
larger than unity. The markups are 1.5 or higher at 74 firms. Our estimation results
thus suggest the significant market power of these firms located in a large variety
of manufacturing sectors.
After the estimation of individual firm markup, we conduct a series of regres-
sion analyses on the determinants of these markups. The paper addresses two
main issues in these exercises. First of all, given the large diversity in the empirical
studies on the magnitude and consequences of the market power of firms in indus-
trialized economies, our study attempts to offer a comprehensive assessment of
the magnitude and major sources of the market power of Japanese firms. Another

1 Bresnahan (1989) surveys major empirical studies in this field.

2 Odagiri and Yamashita (1987), Baba (1995), and our own previous paper (see below) are the few
studies that estimate markups (price–cost margins) in Japanese industries.
3 This paper differs from NOA in three respects. First, the other paper tries to get a general picture

of Japanese firms and estimates the markup over marginal cost of 1643 firms, including construction,
wholesale, retail, and land transportation, firms, while this paper is concerned with only manufacturing.
Second, NOA uses the value-added production function framework, while this paper utilizes the gross
production function incorporating material inputs. Third, this paper analyzes the determinants of the
markup, while the other examines whether the standard concept of an industry is statistically meaningful
by testing the homogeneity of coefficients within the industry.
4 Our estimates include intermediate, material, as well as factor, inputs so that the estimated markups

are the ratios of prices over marginal costs inclusive of these inputs.
5 As we see below, most of the firms produce a variety of products across these industries and they

are located in more than one industry.

6 The JSIC lists roughly 550 four-digit manufacturing industries.
426 ARIGA, OHKUSA, AND NISHIMURA

important issue that we address is the role of competition policy in Japan. We focus
on econometric investigation of various regulatory and punitive measures taken
by the Fair Trade Commission of Japan (Kousei Torihiki Iinkai).
This paper addresses these issues by estimating individual firms’ average of
product-specific markups over marginal cost for different products. The unique
structure of the data and the estimate of markup for individual firms enable us to
address issues that cannot be analyzed easily in cross-sectional studies based upon
industry-level data. Our estimation of markup developed in NOA also provides
simultaneously the estimate for the magnitude of the fixed cost and the effect of
adjustment costs due to the firm’s growth. Using these estimates, we also obtain
the local curvature of a U-shaped marginal cost curve and are able to examine the
technological properties of various industries.
The data on individual markets are also unique. Our data include information
on sales (production) shares of major producers for more than 800 industrial prod-
ucts. This data set can be used to calculate concentration and own-market-share
measures, and they can be utilized in analyzing the past history of anti-competitive
conduct and disciplinary actions documented and enforced by the FTC.
The paper is organized as follows. In the next section, we briefly review the
underlying theoretical model developed in NOA for the estimation of individual
firm markup. Section 3 then extends the model to address the issues of our interest
in this paper. Section 4 reports major estimation results and investigates the effect
of the FTC’s activities on markups. Concluding remarks are given in Section 5.

2. A MODEL OF A MULTI-PRODUCT FIRM

In this section, we derive the basic relation that can be utilized in the empirical
analysis of markup over marginal cost. This is the relationship among the elasticity
of output to inputs, the markup rate over marginal cost, and factor shares. Using this
relationship, we can identify the markup rate from factor and other inputs shares
and information about production technology, without knowing a firm’s input and
output prices, its demand conditions, or the strategic interaction among firms.
In estimating markup, we utilize a method developed in NOA. In that paper,
we derived a fundamental relationship between factor shares, a markup, and tech-
nological parameters determining output elasticity, and we estimated a markup
utilizing this relationship. We assumed a value-added production function and ig-
nored multiplicity of products. In this section, we extend this method and apply it
to the case of a gross production function with material inputs and multiple prod-
ucts. We proceed in three steps. In the following, we utilize the following identifier
conventions:

i firm
k product
t period.
 INDIVIDUAL-FIRM MARKUP IN JAPAN 427
The first step is to determine a fundamental relation among factor shares, the
markup, and the output elasticity for each product. Here, we briefly summarize
the results given in NOA, which contains detailed discussion of the assumptions
and implications of this approach. Let K tik , L ik
t , and Jt be, respectively, firm i’s
ik

capital service input, labor input, and material input to produce the kth product in
the tth period. Firm i’s production function of the kth product is
¡ ik ik ik ¯ i ¢
t = F
Q ik ik
K t , L t , Jt ¯ Ä . (1)

Here, Äi is the set of firmwide parameters which are given to the production of
the kth product.
We make two sets of assumptions. First, we assume that (1) the production func-
tion F ik (K tik , L ik
t , Jt ) is homothetic in (K t , L t , Jt ) and (2) the firm minimizes
ik ik ik ik

production costs, taking input prices as given. Under the homotheticity assump-
tion, the elasticity of output with respect to capital, labor, and material, εik Q , is well
defined by

K tik £ ik ¤ L ik £ ¤ J ik £ ¤
εik
Q ≡ ik
FK t + tik FLik t + t ik FJik t , (2)
Qt Qt Qt

where [g]t is the value of function g evaluated at t. Next, let µik

t be the markup
over the marginal cost such that

ptik = µik
t λt ,
ik
(3)

in which ptik is firm i’s price for its kth product, λik
t is firm i’s marginal cost for
producing the kth product:

∂C ik
λik
t = . (4)
∂ Q ik

Here, C ik is the cost function such that

¡ ¢ £ ¤
C ik rtik , wtik , z tik , Q ik
t = Min rtik K tik + wtik L ik
t + z t Jt
ik ik
subject to (1),

where rtik , wtik , and z tik are the rental price of capital, the wage rate, and the price of
material, respectively, in firm i’s production of the kth product in period t. Finally,
the term α ikX (X = K , L , J ) is the productwise input share such that

£ ¤ rtik K tik £ ik ¤ wik L ik £ ¤ z tik Jtik

α ik
K = ; α L t = ikt tik ; α ik
J = . (5)
t
ptik Q ik
t pt Q t t
ptik Q ikt

Using the above definitions, we have the following simple relationship between
428 ARIGA, OHKUSA, AND NISHIMURA

the output elasticity, the markup, and the input shares7 :

¡£ ik ¤ £ ¤ £ ik ¤ ¢
Q = µt
εik ik
α K t + α ik
L t + αJ t . (6)

Second, we further assume that (i) there exists a fixed cost in production, (ii) the
marginal cost is constant if the firm’s size is unchanged, and (iii) the marginal cost
is increasing if the firm as a whole is expanding or contracting. Property (iii) is
one representation of the adjustment cost in firm growth. In order to incorporate
the above three assumptions, we assume the production function
µ ¯ ¶
¯
ik ¯ 1St
i
F ik K tik , L ik
t , Jt ¯ , Q iN
t
Sti
· µ ¯ i¶ ¸
¡ ¢ ¯
ik ¯ 1St
= Max 0, 1 + γ0ik f ik K tik , L ik t , Jt ¯ − γ ik i N
Q t , (7)
Sti

where γ ik and γ0ik are technological parameters, Sti is firm i’s size, and Q it N is its
normal level of total output. (The empirical counterparts of the latter two variables
will be discussed in the next section.)
In this formulation, γ0ik and γ ik Q it N represent the existence of the fixed cost.
Before the firm ever produces positive output, it has to input sufficient capital, labor,
and material [(K tik , L ik
t , Jt ) such that (1 + γ0 ) f (K t , L t , Jt ) = γ Q t )].
ik ik ik ik ik ik ik i N

The cost of such capital, labor, and material inputs is the fixed cost. A major part of
the fixed cost is overhead, so that the fixed cost depends on the firmwide planned
scale of production, which we call a normal level of total output, Q it N . However,
the magnitude of the fixed cost is likely to differ among firms and products, so that
the coefficients γ0ik and γ ik may differ among firms and products. Our approach is
different from the conventional approach of characterizing the fixed cost as a result
of fixed factors of production: we assume that production organization planned for
a normal level of output is fixed in the short run, but factors of production are
variable and substitutable.
Function f ik is assumed to be homogeneous of degree 1 − δ ik (1Sti /Sti )2 in
its inputs. Thus, marginal cost is constant ( f ik is linear homogeneous) if there
is no change in the size of the firm (1Sti /Sti = 0). However, the production ef-
ficiency is reduced if the firm expands and contracts, since firmwide production
re-organization due to expansion and contraction necessarily strains the firm’s
management resources. This is the essence of the adjustment cost discussed in the
literature of firm growth, often called the Penrose effect. The effect of the adjust-
ment cost may differ among firms and products, and δ ik represents the magnitude
of this effect.
7 Cost minimization implies F = r/ p, F = w/ p, and F = z/ p (superscripts are ignored for ex-
K L J
pository simplicity in this footnote). Then, it is straightfoward to show this relationship by first substitut-
ing FK = r/ p, FL = w/ p, and FJ = z/ p into the definition of the input elasticity and then rearranging
terms using the definition of input shares.
 INDIVIDUAL-FIRM MARKUP IN JAPAN 429
Under (7), it is straightforward to show (see NOA)

½ µ ¶¾ ( µ ¶2 ) µ ¶ µ ¶2
Q it N 1Sti Q it N 1Sti
εik
Q = 1+γ ik
1−δ ik
≈ 1+γ ik
−δ ik
.
Q it Sti Q it Sti
(8)

Here we assume that γ ik and δ ik are sufficiently small, so that the cross-term is
ignored.
Combining (6) and (8), we have

µ ¶ µ ¶2
¡£ ¤ £ ¤ £ ik ¤ ¢ Q it N 1Sti
µik
t α ik
K + α ik
L t + αJ t ≈ 1 + γ
ik
− δ ik . (9)
t
Q it Sti

This is the fundamental relationship from which we can identify the markup
rate µik
t .
The second step is to obtain the firmwide relation among input shares, markups,
and determinants of output elasticities. Through tedious but straightforward cal-
culation (see Appendix A), we have the multi-product counterpart of (9) such
that

X µ ¶ X µ ¶2
¡£ ¤ £ ¤ £ ¤¢ Q it N 1Sti
µit α iK + α iL t + α iJ t ≈ 1 + ωtik γ ik − ωtik δ ik .
t
k Q it k Sti
(10)

On the right-hand side of (10), ωtik is the sales share of the kth product,

pik Q ik
ωtik = ¡ P t ik t ik ¢ . (11)
k pt Q t

On the left-hand side, µit is firm i’s mean marginal markup rate, which is the
cost-share-weighted average of the marketwise marginal-cost markup, such that
¡ ik ik ¢
X rt K t + wtik L ik
t + z t Jt
ik ik
µit = ω̃tik µik
t , where ω̃tik = P ¡ ik ik ¢ , (12)
k r t K t + wt L t + z t Jt
ik ik ik ik
k

and α iX (X = K , L , J ) is the firmwide factor shares such that

P ik ik P ik ik P ik ik
£ ¤ r K £ ¤ w L £ ¤ z J
α iK t = P k tik tik ; α iL t = Pk ikt tik ; α iJ t = P k tik t ik . (13)
k pt Q t k pt Q t k pt Q t
430 ARIGA, OHKUSA, AND NISHIMURA

Taking the logarithm of both sides of (10) and rearranging terms, we have
¡£ ¤ £ ¤ £ ¤¢
log α iK t + α iL t + α iJ t
X µ iN ¶ X µ ¶2
Qt 1Sti
≈ − log µit + ωtik γ ik − ωt δ
ik ik
, (14)
k Q it k Sti

where the relation log(1 + x) ≈ x for x with small |x| is utilized.

The third step is to obtain an empirically estimable relation between observable
variables, based on (14). Note that γ ik and δ ik are the technological parameters
not directly observable, while ωtik , the sales share variable, is not available for
all sample periods in the empirical study presented below. In order to circumvent
these problems, we make additional assumptions. We assume that firms in the
same product market have the same fixed cost parameter and the same Penrose
effect,8

γ ik = γ k for all i (15)

δ ik = δ k for all i. (16)

Let the time average ωik , of ωtik , be such that

1 XT
ωik = lim ωik . (17)
T →∞ T t=0 t

Then, under the additional assumptions (15) and (16), it is straightforward to show
that (14) can be rewritten as
¡£ £ ¤
¤ £ ¤¢
log α iK
+ α iL t + α iJ t
t

X µ iN ¶ X µ i ¶2
k Qt k 1St
≈ − log µt +
i
ω γ
ik − ω δ
ik + wti , (18)
k Q it k Sti

where
µ ¶X µ ¶2 X
Q it N £ ¤ 1Sti £ ¤
wti = ωtik − ωik γ k − ωtik − ωik δ k . (19)
Q it k Sti k

It is natural to assume that the sales-share deviation from its long-run average
ωtik − ωik of a particular product is uncorrelated to the firmwide normal-to-actual

8 It is desirable to test this and following homogeneity assumptions on γ and δ statistically. Unfor-

tunately however, this practically impossible since we do not have a sufficient degree of freedom in
our data set.
 INDIVIDUAL-FIRM MARKUP IN JAPAN 431

total output ratio Q it N /Q it and firm-level growth 1Sti /Sti . Keeping this in mind,
we assume

1 XT
lim wi = 0,
T →∞ T t=0 t

so that wti can be treated as an error term. Equation (18) is the base equation that
we use in the following estimation.

3. AN EMPIRICAL MODEL OF MARKUP AND MARKET STRUCTURE

The model that we presented in the previous section relies only upon the spec-
ification of production technology and cost minimization. As such, the model
can accommodate a variety of specifications of production and pricing decisions,
including that of markups. We take advantage of this structure and exploit the inter-
firm and inter-market variations in the variety of characteristics related in one way
or another to (1) seller concentrations, (2) market shares, and (3) the nature and
possible degree of collusive behavior of firms within a market.

3.1. Determinants of markups: Conjectural Variations and Pricing Policy

Since the base Eq. (18) above is derived essentially as the cost minimization,
(18) can be combined to a model of product price determination. Consider a
representative firm’s pricing policy, facing demand schedule D ik in market k,
£ ¡ ¢¤
ptik = arg max ptik Q ik
t −C rt , wtik , z tik , Q ik
ik ik
t ,

where
¡ ik © jk ª ¢
t = D
Q ik pt , pt : j = 1, . . . m ; 2kt ,
ik

in which 2kt denotes the vector of exogenous variables. The conventional short-run
profit maximization condition is given by
P i jk i jk
ηtik − j ηt 1t
µik
t = P i jk i jk ,
ηtik − j ηt 1t − 1

i jk i jk
where ηtik and ηt are own and cross-price elasticities, respectively, and 1t is
the conjectural variation such that
jk
i jk ptik ∂ pt
1t ≡ .
pt ∂ pt
jk ik
432 ARIGA, OHKUSA, AND NISHIMURA

Then, the firm-level markup is (see (12))

P i jk i jk
X ηtik − j ηt 1t
µit = ω̃tik P i jk i jk .
k ηtik − j ηt 1t − 1

A variety of variables may influence

P i jk the firmwide markup through their effects
i jk
on two determinants, ηtik and j ηt 1t . Since our principal interest lies in the
long-run cross-sectional variations in the markup, we need to filter the cyclical
fluctuations.9 After netting out cyclical fluctuations, we consider three sets of
variables that potentially influence one of the two determinants of the markup.
1. Product Characteristics: These are likely to influence price elasticities of
demand. We use advertisement and sales promotion expenditure to represent the
degree of product differentiation.
2. Market Characteristics: To the extent that higher seller concentration is con-
ducive to collusive pricing behavior, we use conventional concentration measures
to represent market characteristics, as well as individual-firm market shares to
represent the potential effect of market dominance.
3. FTC’s Policy Measures: These variables may influence the markup rate
through their impacts on collusive conducts, either by deterrent effects or by direct
injunctions to prohibit specific conducts. It is also conceivable that some policy
measures may directly influence the market characteristics; for example, the law
prohibits overly speculative sales promotion prizes, thereby possibly influencing
the nature of product differentiations in markets.

3.2. Data and Econometric Issues

The firm-level data that we use are based upon official financial statements of
major manufacturing firms submitted to the Ministry of Finance. This data set can
be considered as the most broadly based panel of large Japanese manufacturing
firms. The data set includes all the firms listed in major stock exchanges, and
it also includes major non-listed firms. It contains information about the sales,
the operating profits, the employment compensation, the depreciation allowance,
the investment expenditure, the total asset value, and the book value of existing
capital stocks of each firm, as well as other information. The data are annual, and
the sample period is 1975–1994.

9 The direction of the cyclicality of the markup has been intensively discussed in the literature (see
Rotemberg and Woodford, 1991). In theory, it can go either way, depending on information availability
and other factors, even though underlying market structure is the same. For example, Green and Porter
(1984) suggest a procyclical markup under imperfect information and Rotemberg and Saloner (1986)
stress a counter-cyclical one under perfect information although both assume implicit collusion among
firms. Similarly, Bils (1987) and Gottfries (1991) derive a counter-cyclical markup in the customer
market, but Nishimura (1989) implies a procyclical markup. The above argument suggests that whether
the markup is procyclical or not is essentially an empirical problem.
 INDIVIDUAL-FIRM MARKUP IN JAPAN 433
TABLE I
Summary Statistics (1), Firms: Sample Firms = 451,
Firm-Observation Years = 8921

Mean Std. Min Max

Assetsa 131.203 315.147 0.447 4130.666
Salesa 119.604 271.966 0.402 4550.086
NORCUR 0.0484 0.0598 −0.368 1.105
KGROWTH 0.0493 0.298 −0.969 11.310
CFAS 0.0484 0.059 −0.368 1.105
Note. Variables NORCUR KGROWTH, and CFAS and are de-
fined in the text and are used in the base-line regression (13).
a Figures in billion yen.

The second set of data on product markets is taken from “Nihon Market Share
Jiten” (Yearbook of Market Shares in Japan) (Yano Research Institute, 1995, here-
after Yano), which collects data on the production of finely classified individ-
ual products and services. In the book, roughly 1500 products and services are
covered.10 For each individual market, information about major producers and
their sales volumes is collected.11 We used all of the data on manufactured prod-
ucts, comprising roughly 720 product lines, covering virtually the entire universe
of the important manufactured products in Japan.12 In order to mesh the product
data with the firm-level data, we looked for the entry of sample firms in these
market data. We also classified these products into 130 four-digit manufacturing
industries, following the JSIC (Japan Standard Industry Classification). We treat
each of these four-digit sectors comprising the relevant product market.13 Hence,
each of the 720 or so product market data is grouped into one of the 130 four-digit
manufacturing industries.14 Rather than assigning each firm a unique four-digit
industry code affiliation, we consider each sample firm as a multi-product firm
whose lines of products are picked up from Yano (1995).
Table I shows the panel of firms used in the analysis. In the data set, there are
451 firms with 8921 firm-year observations. The sample period is between 1975
and 1994. Most of the sampled firms continue to exist and their data are available.
The way these variables are constructed is explained in Appendix B, and Table I

10 Most of the data collected in Yano (1995) are based on 1994 surveys.
11 When production shares are given in quantities, we used the unit price of the corresponding product
in the Census of Manufacturers, 1995.
12 One major shortcoming of Yano (1995) is the lack of data on imports.
13 The Census of Manufacturers, the most comprehensive establishment-level survey of manufactur-

ing in Japan, lists roughly 1800 JSIC six-digit individual industrial products. Yano (1995), on the other
hand, covers roughly 850 industrial goods. The latter, however, does not cover the whole spectrum
of industries and instead focuses more narrowly on important industrial products. For the products
covered, Yano (1995) classifies individual products into groups finer than the JSIC six-digit level.
14 Among 130 four-digit industries, 49 of them have only one entry in Yano (1995) and 22 industries

have two entries. The number of industries with 3 to 10 entries are 10, 7, 9, 8, 6, 5, 3, and 4, respectively.
One industry has 49 entries.
434 ARIGA, OHKUSA, AND NISHIMURA

TABLE II
Summary Statistics (2), Markets: Number of Individual Commodities, 723,
Number of Four-Digit Industries, 130, Year = 1994

Mean Std. Min Max

Salesa 473.03 1010.06 0.007 9573.58

Herfindahl index 0.285 0.184 0.072 1.00
Three-firm concentration ratio 0.776 0.149 0.483 1.00
a Figures in billion yen.

gives descriptive summary statistics for these variables in our sample. It might
be noted that the sampled firms represent roughly 20% of all the listed firms in
Japan, and roughly 35% of all listed manufacturing firms. Summary statistics on
markets are shown in Table II. The aggregate size of the markets covered in our
data set is 89 trillion yen in 1994, which corresponds to roughly a third of the total
gross shipments (266 trillion yen) of all manufactured goods in Japan. As the data
shows, the average three-firm concentration ratio is 0.77, considerably higher than
the average from previous selective studies done by the FTC.15

3.3. Model Specifications

In the previous section, we obtained a basic relation to be estimated for individual
firm i (replacing ≈ with = for notational simplicity),
¡£ ¤ £ ¤ £ ¤¢
log α iK t + α iL t + α iJ t
X µ iN ¶ X µ ¶2
Qt 1Sti
= − log µit + ωik γ k i
− ω ik δ k
i
+ wti .
k Q t k St

To estimate this equation, we use proxies for the normal-to-actual total output ratio
Q it N /Q it and the change in the firm size, 1Sti /Sti . The variable Q it N /Q it is proxied
by the ratio of the firm’s trend total output to the current total output, NORCURit .
For 1Sti /Sti , we use the growth rate of the firm’s capital stock, KGROWTHit as its
proxy.
Now we have to filter out cyclical fluctuations in the markup. To do this, we
assume that (a) the individual-product markup rate depends on the condition of
the own-product market, (b) the sensitivity of the markup to market conditions,

15 According to a study conducted by the FTC in 1979, the three-firm concentration was 0.7 or higher
in 86 cases, 0.5 to 0.7 in 80 cases, 0.3 to 0.5 in 92 cases, and less than 0.3 for 40 cases. On the other hand,
there are reasons to believe that the markets used in our analysis are fairly representative and the data
are more accurate. First of all, the corresponding firms are the largest manufacturing firms in Japan,
and it is well known that larger firms tend to produce in more concentrated industries. Second, Yano
(1995) segments markets into finer categories than most of the previous studies, focusing narrowly on
the important industrial products. Finer classifications of products naturally increases average market
concentration.
 INDIVIDUAL-FIRM MARKUP IN JAPAN 435
is the same among firms,16 (c) the individual product-market condition is highly
correlated with the firm’s overall market condition, and (d) the firm’s overall mar-
ket condition is well approximated by the firm’s cash-flow-to-asset ratio. These
assumptions imply the specification of markup behavior

t = a0 + φ CFASt ,
log µik ik k i
(20)

where a0ik is a parameter and CFASit is the cash-flow-to-asset ratio of each firm
P
that we used in NOA. We also utilize the approximation log µit ≈ k ωik log µik t
in our empirical analysis. Then we have (replacing ≈ with =)
X
log µit = a0i + ωik φ k CFASit , (21)
k

P
where a0i ≡ k ωik a0ik .
Putting these specifications together, our base-line regression is of the form
X ¡ ¢
FSit = −a0i + ωik γ k NORCURit − δ k KGROWTHit − φ k CFASit + wti , (22)
k

where FSit is the log of the sum of factor and other input shares in period t and ωik
is firm i’s time-average of the sales weight of product k. We use the 1994 value of
ωtik (reported in it Yano (1995)) as a stand-in for this parameter. The disturbance
wti might be correlated with other variables in the right-hand side of (22). Thus,
we use instrumental-variable estimation. In the following analysis, the instruments
are lagged right-hand side variables (except for constant and industry dummies)
and those of industry averages used in each of the regressions.

3.4. Base Results

The results for the base-line case is reported in Table III. In this table, figures
reported for γ , δ, and φ are the summary statistics for panel regression estimates
for each of the four-digit manufacturing industries. Overall, we obtained fairly
sharp estimates. The majority of the estimated coefficients have the correct signs
(non-negative): Roughly 70, 60, and 75%, respectively, of the estimated γ , δ, and
φ are positive and significant at the 5% level. About 25% of the coefficients have
the correct signs (non-negative), and they are not significantly different from zero.
Only a remaining 5% (20 out of 390 = 130 ∗ 3) of the coefficients have wrong signs
(negative), but only two of them are significant.
Across industries, we observe a clear pattern that the estimated coefficients γ , δ,
and φ are positively correlated. Namely, industries with a strong effect of short-run

16 In the homogeneous-product framework, NOA showed that this is in fact the case in the Japanese

industries they considered.

436 ARIGA, OHKUSA, AND NISHIMURA

TABLE III
Summary Statistics of Base-Line Model Estimates

γ δ φ

All |t| > 2 |t| < 2 All |t| > 2 |t| < 2 All |t| > 2 |t| < 2

N 130 85(2)a 45(16)a 130 92 38(2)a130 98 32(2)a

Mean 0.156 0.274 −0.066 0.142 0.198 0.0036 0.980 1.109 0.585
Median 0.0097 0.164 0.0016 0.0153 0.0224 0.0031 0.584 0.601 0.538
Min −1.807 −0.0322 −1.807 −0.086 0.0020 −0.0860 −0.785 0.511 −0.785
Max 6.564 6.564 0.165 5.563 5.563 0.0561 10.202 10.202 3.087
1st Qrt. 0.0023 0.007 −0.0245 0.0047 0.0118 0.0014 0.541 0.559 0.513
3rd Qrt. 0.0311 0.0523 0.0047 0.0347 0.0461 0.0084 0.667 0.685 0.594
a Number of negative estimates in parenthesis.

fixed costs, i.e., those with large value of γ , tend also to have large δ (significant
Penrose effect) and φ (pro-cyclical markup).
When we classify industries in terms of relative magnitudes of estimated values
of δ and γ , several interesting patterns emerge. They are shown in Table IV. In many
electric machinery and industrial machinery industries, both of these coefficients
are statistically significant and large, suggesting a strongly U-shaped marginal
cost curve. On the other hand, many processed foods (finished goods) industries
exhibit essentially flat marginal cost curves. Some of relatively low-tech metal

TABLE IV
Production Technology Characteristics

(1) U-shaped AC
1225 Fish paste products 1229 Misc. seafood products
1231 Canned preserved fruits 1242 Soy sauce
1295 Soy bean curd (incl. fried) 2213 Plastic pipe fittings
2292 Plastic containers 2833 Heated air and hot water heating systems
(2) Flat AC
2038 Synthetic rubber 2221 Plastic film
2092 Agricultural chemicals 2441 Leather footwear
2811 Tin cans 2899 Fabricated metal products, n.e.c.
2942 Metal working machinery 3231 Medical instruments

(3) Decreasing returns

1251 Sugar (exc. sugar refining) 1293 Noodles and pastas
1799 Furniture and fixtures 2052 Soaps and synthetic detergents
2212 Plastic pipes and tubes 2733 Aluminum rolling

(4) Increasing returns

3217 Analytic instruments
Notes. (1) U-shaped AC: γ and δ are significant and in the largest quartile. (2) Flat
AC: γ and δ are in the smallest quartile. (3) Decreasing returns: γ is in the smallest
quartile and δ is significant and in the largest quartile. (4) Increasing returns: δ is in
the smallest quartile and γ is significant and in the largest quartile.
 INDIVIDUAL-FIRM MARKUP IN JAPAN 437
products industries also fall into this category. Compared to these two cases, only
a few industries have large γ and small δ, or vice versa. These patterns are broadly
in accordance with conventional wisdom on the cross-sectional characteristics of
industry technology and scale effects on costs.
Table III also shows the estimate of the markup’s cyclical sensitivity φ. The
markup shows statistically significant pro-cyclicality in most (98 out 130) of the
industries. Only two out 130 industries have negative cyclical sensitivity, but their
coefficient is not statistically significant. The cyclical effect is large in industrial
machinery, electric machinery, and chemical industries. In many consumer goods
industries, most notably those in processed foods sectors, markups are largely
acyclic. The result is broadly consistent with previous studies examining the cycli-
cality of Japanese markups. For example, Nishimura and Inoue (in press) could
not reject the null hypothesis of no cyclicality in the case of the food processing
industry’s markup, whereas markups in other branches in manufacturing do exhibit
cyclical fluctuations.
3.4.1. Sample-period average markup of individual firms and industries. In
order to assess the magnitude of the market power that Japanese firms possess,
we used the regression results and computed the individual firms’ sample-period-
bi , such that
average of marginal-cost markup in a logarithm, log µ

bi = 1 TXi −1

log µ log µit , (23)

Ti t=0
where Ti is the number of observations for firm i. Ti may differ from firm to firm
since some firms terminated and some others emerged within our sample period.
From (21), we immediately get
X X
Ti −1
bi = a i +
log µ d i,
ωik φ k CFAS di = 1
where CFAS CFASit . (24)
0
k
Ti t=0
Table V and Fig. 1 report the result of the cross-sectional analysis based on (24).
For about 50% of the firms the sample-period-average markup µ bi is significantly

TABLE V
bi
Estimated Individual-Firm Markup µ

Panel (1): Distribution

Firm N Mean Median Min Max 1st Qrt. 3rd Qrt.

451 1.291 1.110 0.483 13.96 1.036 1.269

Panel (2): t-values
Significant at 5% Significant at 10% Not significant Total
bi > 1
µ 229 83 96 408
bi < 1
µ 2 0 41 43
Total 231 (51.2%) 83 (18.4%) 137 (30.4%) 451
 438
ARIGA, OHKUSA, AND NISHIMURA

bi . Note that two outliers larger than 5 are excluded from the figure.
FIG. 1. Distribution of estimate individual firm markup µ
 INDIVIDUAL-FIRM MARKUP IN JAPAN 439

greater than unity at the 5% level.17 In contrast, we find only two firms whose µ bi
is significantly smaller than unity at the 5% level. If we adopt a 10% significance
level, roughly three quarters of the sample firms have a markup µ bi significantly
greater than unity. This table thus reveals that the markup rate is significantly
greater than unity in most of the sample firms, and suggests the non-negligible
market power possessed by firms in this panel. The result is broadly in line with
previous studies (see, for example, Odagiri and Yamashita (1987) and Shinjo
(1977)), although previous studies estimated the markup over the average cost
rather than the marginal cost.
3.4.2. Market shares and concentration. The estimated firm-level markup is
the weighted average of its markups in different product markets. We exploit this
structure and investigate the possible effect of market structure on markups.
The logarithm of the product-specific markup log µik t in (20) is determined by
several market conditions m kjt :
X
log µik
t = β0 +
ik
β j m kjt .
j

bi in (23) can
Therefore, the sample-period-average of the firm-level markup, log µ
P ik
approximately be written as (here we use an approximation log µt ≈ k ω log µik
i
t
as in (21))
X
bi = β i +
log µ ck ,
βjm (25)
0 j
j

where

X X
Ti −1 X

β0i ≡ ωik β0ik and ck ≡ 1

m ωik m kjt .
j
k
Ti t=0 k

Table VI reports cross-sectional regressions of the form (25), wherein as market

conditions m ck we use (a) the individual firm’s market share, (b) its advertizement
j
and sales promotion expenditure as a stand-in for product differentiation, and
(c) alternative measures of market concentration. The results indicate that the effect
of the own-market share is (either marginally or highly) statistically significant and
large. The estimated coefficient of the own-market share suggests that the average
markup of a firm with a 20% market share is roughly 5 to 8% higher than that of
a firm whose average market share is 5%. The advertizement-expenditure effect
is large though it is marginally significant. Concentration also increases markups,
although its effect is only marginally significant and quantitatively modest.

bi differs significantly
17 The t values reported in Table V are the ones for testing whether or not log µ

from zero.
440 ARIGA, OHKUSA, AND NISHIMURA

TABLE VI
Market Structure and Markups (Cross Section Regressions)

Variable Impacts on the level of markup

Own market share 0.317 [1.74] 0.336 [1.75] 0.462 [3.65]
Three-firm concentration ratio — 0.325 [1.60] 0.136 [1.58]
Herfindahl index 0.440 [1.69] — —
Advertizement/sales promotion 0.756 [1.79] 0.821 [1.77] —
Note. The t values are in brackets. The left-hand side variable is the fixed effect
term a0i for individual firms. (Number of samples = 451.)

4. THE IMPACT OF THE FTC’S REGULATORY

MEASURES ON MARKUPS

4.1. The FTC’s Regulatory Actions

In this section we investigate the effectiveness of the FTC’s regulatory policies18
in curtailing monopolistic conduct in individual markets. The most important pol-
icy instrument used by the FTC is administrative injunctions and punitive actions
called shinketsu.
The process leading to shinketsu is in principle similar to court procedure, with
the FTC’s investigation body acting in the prosecutor’s role. However, the law
allows the skipping of the court-like procedure if the accused party concedes
before the process begins. In this case, a formal shinketsu is issued immediately
and such shinketsu is called kankoku shinketsu (kankoku (consent order) for short).
In the past, very few cases have gone through the court-like process so that the
kankoku is effectively a final decision and it constitutes the vast majority of the
FTC’s injunctions and punitive actions. The FTC announces kankoku toward firms,
organizations, and/or individuals suspected of conducts in violation of the Anti-
monopoly Law.19 A kankoku consists of specific corrective measures that the said
firms, organizations, and/or individuals should take in order to avoid further actions
by the FTC. After the amendment of the Anti-Monopoly Law in 1977, the FTC
has also been able to impose a compensatory surcharge.
This suggests that kankoku, although being an administrative procedure and not
a legal punitive action, is the strongest and largely the final action against anti-
monopoly conduct. In recent years, the FTC has investigated more than 200 cases
each year and roughly 15 to 20% of them have resulted in kankoku. If the FTC

18 See Masuda (1997) for a thorough review and an analysis of the FTC’s activities and their impact.

The FTC’s regulatory procedures and their major changes are discussed in Murakami (1999).
19 The violations are largely classified as (1) conduct to monopolize markets, (2) collusive conduct,

or (3) unfair trade practices (mostly in the context of vertical restraints). The FTC specifies the nature
of the violation in each kankoku. In this paper, we do not divide the FTC’s actions according to these
classifications. Instead, we selected cases according to the following criteria: (1) the accused are either
private manufacturers or distributors and (2) the nature of violation is either collusive pricing or retail
price maintenance.
 INDIVIDUAL-FIRM MARKUP IN JAPAN 441
TABLE VII
List of FTC Policy Variables

Variable name Number of casesa Number of industriesb Expected signs

Kankoku injunctions [inj kt ] 53 31 —
−Regional dummy [regd kt ] 31 19 − (on inj kt )
−Manufacturer dummy [mfgd kt ] 43 28 + (on inj kt )
Monitoring1 [monit1 kt ] 106 19 —
Monitoring2 [monit2 kt ] 391 42 —
Compulsory reports [compr kt ] 56 18 —
a Total number of industry-year observations in which each of policy measures are taken.
b Total number of industries to which each policy measure is taken at least once during 1975–1994.

considers a case not strong enough to warrant kankoku but is still suspicious of
important unlawful conducts, the FTC may issue a keikoku, or a chui (both can
be translated as “warning”).
The FTC has also other policy measures to monitor market conduct and pre-
empt collusive behavior. Many of them are conducted as covert investigations and
informal guidelines given to the suspected firms. Many of these activities are not
made public and thus are not available for our purpose. Instead, we use three overt
measures as they are reported in the annual white paper of the FTC each year.
The first is the list of industries which FTC considers as being potentially monop-
olistic and conducive to anti-competitive conduct. The list is thus considered an
announcement that the FTC is closely monitoring the conduct in these markets.
The second is the list of products for which the FTC closely monitors possible
collusive price increases. The last is the list of products for which the FTC asked
specific producers to report on their decision to raise their product prices. In the
last case, the FTC’s action is prompted by what appears to be a concerted price
increase by major producers. For a list of FTC policy variables, see Table VII.

4.2. Econometric Analysis of the FTC’s Regulatory Measures

In the analysis that follows, we would like to test two hypotheses on the regu-
latory actions taken by FTC.
1. Hypothesis 1: The FTC’s variety of administrative punitive actions are effec-
tive in curtailing anti-competitive conduct, and thus are able to reduce the markup
of firms in the targeted markets.
2. Hypothesis 2: The FTC’s actions are correctly aimed at industries and prod-
ucts wherein substantive departure from competitive pricing is suspected and that
also are judged economically more important.
To proceed, we use a set of dummy variables, defined below.20

20 Block et al. (1980) employ a similar approach to test the deterrent effect of prosecutions for price
fixing by the Department of Justice.
442 ARIGA, OHKUSA, AND NISHIMURA

TABLE VIII
Panel Regression on the FTC’s Policy Variables

Policy variables Impacts on markup

Injunctions1 inj kt ∗ m f gdtk — −0.010 [.32] −0.010 [.32]
Injunctions2 inj kt ∗ r egdtk — 0.061 [.74] 0.60 [.74]
Monitoring1 monit1 kt −0.032 [1.18] — 0.014 [.018]
Monitoring2 monit2 kt −0.043 [3.02] — −0.005 [1.61]
Compulsory reports compr kt −0.083 [2.41] — −0.046 [1.68]
DWH Test 2.160 1.079 3.877
Note. The t-values are in brackets. Regressions also include the variables in the base-line
model.

½ ¾
=1 if FTC’s mth policy varible is applied to market k at time t
FTCm
k,t =0 otherwise

The effects of policy variables are represented by

X
t = ²0 +
log µik ik
²m FTCmk,t ,
m

which is substituted for log µikt in the base model regression given in (21) and (22).
The equation is estimated as a fixed effect model.
Let us start with the effect of the kankoku variable. We include in the regressions
two additional dummy variables. First, region is the dummy variable that indicates
that the suspected firms operate in specific local markets only. In this case, the ef-
fect of the FTC’s kankoku injunctions may be somewhat limited. Second, mfg is the
dummy variable that identifies cases in which injunctions are issued to manufac-
turing firms. The dummy variable is zero if injunctions are issued to distributors.21
In most of the cases wherein distributors are prosecuted, the suspected violations
concern mostly retail price maintenance. We expect kankoku to generate a stronger
impact if it is issued directly to manufacturers.
Table VIII shows our regression results. The effect of kankoku on markup is
essentially zero. In this and many other possible specifications, we could not reject
the null hypothesis that the estimated coefficient of kankoku is zero.
Next we move on to the other policy variables. Here the monitoring1 dummy
corresponds to the industry and the year in which the FTC announced that they
suspected possible anti-competitive conduct, whereas the monitoring2 dummy
corresponds to the product and the year that the FTC specified an industry as
being suspect of collusive pricing behavior. The complusory report dummy is the
product and the year for which the FTC asked specific producers to report on their
price decision. For monitoring1, we obtained the expected signs but they were not

21 We exclude all cases in which the case does not involve manufacturing industries, most notably

the bid-rigging of local construction companies.

 INDIVIDUAL-FIRM MARKUP IN JAPAN 443
statistically significant. For the monitoring2 and compulsory report variables, the
estimated coefficients are large negative values and both (highly or marginally)
are statistically significant.
Our results suggest that the latter two are more effective since they are directed
more narrowly toward specific conduct in pricing. Unlike the other variables,
compulsory report is prompted by an actual price increase that the FTC suspects
is collusive. As such, the FTC ordered individual firms to submit reports on their
decision to increase price. These variables have large impacts: in one regression the
effect of monitoring2 is to reduce markups by 4%, whereas the effect of compulsory
report is roughly twice that size.
To sum up, the effects on markup of the FTC’s policy measures differ consider-
ably according to whether formal injunction action, kankoku, or other less formal
measures were used. The effects of the latter measures are of the expected signs
and two of the three variables are statistically significant, whereas we basically
find no effect of the first variable on the markup.
4.2.1. Potential endogeneity and other econometric issues. To the extent that
the FTC’s regulatory actions are prompted by suspected unlawful firms’ conduct
and/or oligopolistic market structure, policy variables may be endogenous, creating
estimation biases in the regressions results in Table VIII. To assess the possible
endogeneity of policy variables, we conducted DWH test.22 The figures shown in
the bottom of each column show the test statistics. Under the null hypothesis that the
policy variables are not correlated with the error term in the regression, this statistic
is distributed according to a χ 2 distribution with a degree of freedom equal to the
number of policy variables in each regression. As is evident in this table, we cannot
reject the null hypothesis in any of the regressions with a conventional confidence
level. To reject a null at the 5% confidence level, the statistic must be larger than
5.99, 7.81, and 9.48, for two, three, and four policy variables, respectively. Based
upon the test results, we therefore rule out the possibility that policy variables are
endogenous.
Another potential problem with the regressions in Table VIII is possible mis-
specification, in particular of the timing of policy actions and their impacts. For
example, For example, our model assumes that the effect of a policy does not
depend upon duration. it may be argued, however, that the effect of a policy action
is once-and-for-all so that the policy impact is concentrated in the first year that an
action is taken toward a particular industry. Alternatively, it is conceivable also that
the same policy has different effects depending upon the duration of the policy.
Moreover, it is possible that the precise timing of an action and its impact may
be misrepresented in the current model. For example, suppose a policy measure is
enacted in December of a particular year. The impact, if any, of the policy is likely
to be recordewd in the observation for the next year.23

22 See, for example, Davidson and MacKinnon (1993) for detailed explanations of the procedure.
23 It is also possible that the actual impact takes place earlier than the recorded timing if the FTC
informs the targetd firms or industries of the policy action before the announcement.
444 ARIGA, OHKUSA, AND NISHIMURA

TABLE IX
Characteristics of Targeted Industries

Policy measures Market sizea Cr3

All samples 504 0.756
Kankoku > 0 528 0.737
Monitoring1 > 0 646 0.791
Monitoring2 > 0 700 0.812
Comp. report > 0 1120 0.841
a 1994 billion yen.

To tackle these timing issues, we tested a variety of specifications, including

(1) polynominally distributed patterns of policy impacts geometrically declining
as the policy is applied continuously over many years, (2) replacing current policy
dummies with those which equal unity only in the first year of policy action,
(3) replacing current policy dummies with those which equal unity in the year
immediately before the first year. We found no substantial differences between the
base model and any of these alternative specifications.24 In particular, we find that
the kankoku policy variable is not significant (and often has the wrong sign) and
also that monitoring2 and compulsory reports have the correct signs and are often
significant at the 5% level.
4.2.2. Hitting the right targets? Our results so far show that the FTC has
largely done its job well at least in monitoring and guidance activities: they have
succeeded in substantially reducing the level of markup. However, our findings
may substantially fall short of providing sufficient supporting evidence that the
FTC has done its job efficiently. Our foremost concern in evaluating the FTC’s
track record is the fact that the FTC in Japan is seriously under-manned and its
human, political, and administrative resources are severely limited.25 Given the
severe resource constraint, our next question is whether or not the FTC has chosen
the right (important) targets in order to best utilize its resources.
Table IX shows the characteristics of targeted industries, i.e., those for which
the FTC’s policy actions have been taken. We show the industry size and the
three-firm concentration measure. Several observations follow immediately from
the table. First of all, kankoku, or administrative injunctions, are not aimed at
either particularly important or highly concentrated industries. As a matter of
fact, injunctions have been issued repeatedly in the past against a relatively small
number of industries. We suspect that the FTC’s track record in injunctions reflects
primarily their judgement regarding the seriousness of the suspected violation, and
not necessarily the magnitude of possible welfare or efficiency losses incurred by

24 These regression results are available from the authors upon request.
25 The FTC is very small: its 1997 budget was 5.6 billion yen, and it employed roughly 550 people,
including 125 located in seven branch offices.
 INDIVIDUAL-FIRM MARKUP IN JAPAN 445
these suspected violations.26 As a matter of fact, as a quasi-judiciary branch of the
government, it is unlikely that the FTC has much discretionary power to liberally
apply injunction measures toward selected industries. Instead, the FTC is bound
to follow the due process of investigating and sanctioning violations of the law.
In contrast to the track record for kankoku, Table IX shows that the FTC has
concentrated its activities in larger and highly concentrated industries for other, less
formal and weaker actions. This also makes sense because the FTC can apply these
policy measures toward industries and firms that they suspect as being oligopolistic
or collusive. Naturally, the FTC focused their resources on monitoring and giving
warning signals to larger and more highly concentrated industries. These findings
are also consistent with our regression results on the impact of these measures
on the markup. FTC policy has the strongest impact on industry markups when
the FTC applies non-punitive actions that are designed to send warning messages
toward targeted industries. On the other hand, injunction measures do not seem to
have a significant impact upon the markup.
4.2.3. Discussion. Insofar as we evaluate FTC performance purely in terms of
efficiency gains, our estimation suggests that the FTC’s scarce resources should be
allocated more to its monitoring/administrative guidance activities than to formal
investigations leading to kankoku. There are many reasons to be cautious, however,
in assessing the relative merits of the FTC’s activities. First of all, just like any other
legal enforcement body, the FTC’s foremost objective is to deter law violations,
not to maximize efficiency gain.
Punitive actions are more powerful measures than other activities such as mon-
itoring or guidance. As a matter of fact, an argument can be made that non-
compulsory measures such as guidance can be effective only under the imminent
threat of these actions. The deterrent effect of punitive measures may not be ad-
equately estimated in our framework. Closer to home, we need also to remind
ourselves that our estimations rely exclusively on samples of large firms. Kankoku
and other formal actions might well have had large impacts upon the pricing policy
of smaller firms and non-firm entities. Last, but not least, there exist potential haz-
ards in the FTC’s less formal activities as they are not reported officially, mainly to
secure the anonymity of suspected firms and individuals. Inevitably, such activities
lack transparency and may well invite a variety of moral hazards.27
In spite of these reservations, there are also arguments in favor of strengthening
the FTC’s monitoring and guidance activities. First of all, we expect that even
if these activities are not punitive in nature, disclosing the nature of suspected

26 Recall that kankoku is practically the strongest measure available to the FTC. The FTC must be

able to substantiate its claim and justify its injunction decisions, first at the FTC’s quasi-court and
possibly also at a (real) court, as the accused can appeal to the court. (In the past, however, the FTC
has had close to a 100% winning record in court).
27 One Diet member and a firm executive were prosecuted for bribing and receiving bribes in an

attempt to influence an FTC investigation. The Diet member was later impeached by the Diet and lost
his seat.
446 ARIGA, OHKUSA, AND NISHIMURA

conduct and the identity of suspected firms can be damaging enough for firms. The
FTC has been conservative, however, regarding information disclosure, in fear of
complaints from firms. Judging from the significant effect of the compusory reports
variable, we expect a substantial impact from fuller disclosure of information and
judgement on the market conduct of individual firms and markets.
Moreover, there exists concern over the effectiveness of punitive actions. Before
the 1977 amendment, there was no surcharge penalty even if the prosecuted party
failed to comply the injunctions. The 1977 amendment introduced a surcharge
designed basically to absorb estimated extra profits earned by collusive actions.
Many suspect that not only that the surcharge is too small28 but also that the rule
governing the amount of the surcharge is ill-fit. In particular, the rule does not
take into consideration the damage incurred by consumers and other parties in the
market. The FTC is given no discretionary power to adjust the surcharge according
to these damages. Given the fact that class action suits by private individuals or
firms are very difficult and, so far, close to non-existent in Japan, it seems possible
that additional resources spent on policing law violations may not be very effective.

5. CONCLUDING REMARKS

In this paper, we employed an estimation procedure that relies only upon infor-
mation on production technology to obtain an estimate of the firm-level markup.
Our results indicate that most of major manufacturing firms in Japan are able to
elevate prices substantially above their marginal costs. We also found substantial
positive impact on markup not only from market concentration and product dif-
ferentiations but also by firms’ own market shares. Given the diversity of markets
and products covered in the sample, we believe that our analysis offers a ten-
tative but reasonable bird’s eye view of market power and its consequences for
pricing in the Japanese manufacturing industries. The view that we offer is close
to conventional wisdom. The relation between market concentration and markup
is marginally significant and quantitatively small, suggesting clearly that there
exists no clear-cut strong causal relation linking concentration to markups. The
finding is not new, but we should note that our results are based upon the esti-
mate of individual firm-level markup, in contrast to most of the previous studies
using industry-level cross-sectional data. We also find it significant that the own-
market share does have a statistically significant and sizable positive impact on
markup.
To our knowledge, ours is the first paper to systematically investigate the effec-
tiveness of the FTC’s policy measures on industrial pricing. The result is mixed: we

28 According to Masuda (1996), the total surcharge for 1977 and 1991 was 23.5 billion yen for 1190
firms and other entities, or 12 million yen per entity. On the other hand, according to rumors in the
industry circle, kankoku is still a powerful weapon because executives of firms receiving kankoku will
be deleted from the list of candidates for imperial decorations.
 INDIVIDUAL-FIRM MARKUP IN JAPAN 447
find significant impact by the non-punitive measures taken by the FTC, whereas
its strongest bullet, injunctions, do not appreciably influence the markups of our
sample firms.
Due primarily to data limitations, we leave many interesting and important
issues for future research. Among other concerns, we need to collect data on
changes in market size, concentrations, and shares in order to conduct full-fledged
panel regressions. Expanding the scope of the research to smaller firms also has
obvious merits, particularly for estimating the impact of FTC injunctions in a more
satisfactory manner.29

APPENDIX A: DERIVATION OF (10)

Utilizing definitions (5) and (11), we have

µX ¶
¡£ ¤ £ ik ¤ £ ik ¤ ¢
rtik K tik + wtik L ik
t + z tik Jtik = ptik Q ik
t K t + αL t + α J t .
ωtik α ik
k
(A.1)
Substituting (A.1) into (12) we have
X ¡£ ¤ £ ik ¤ £ ik ¤ ¢ X ik ik ¡£ ik ¤ £ ¤ £ ik ¤ ¢
µit ωtik α ik
K t + αL t + α J t = ωt µt α K t + α ik
L t + αJ t .
k k
(A.2)
From definition (13), we get
£ i ¤ £ ¤ £ ¤ X ¡£ ¤ £ ik ¤ £ ik ¤ ¢
α K t + α iL t + α iJ t = ωtik α ik
K t + αL t + α J t . (A.3)
k

Substituting (A.3) into (A.2) we have

¡£ ¤ £ ¤ £ ¤ ¢ X ik ik ¡£ ik ¤ £ ¤ £ ik ¤ ¢
µit α iK t
+ α iL t + α iJ t = ωt µt α K t + α ik
L t + α J t . (A.4)
k

Substituting (9) into (A.4), we obtain

" µ iN ¶ µ #
¡£ ¤ £ ¤ £ ¤ ¢ X i ¶2
Q 1S
µit α iK t + α iL t + α iJ t ≈ ωtik 1 + γ ik t
− δ ik t
,
k Q it Sti

P
which immediately implies (10) since k ωtik = 1.

29 A more satisfactory approach would be to estimate the “supply” schedule of the FTC’s policy

actions jointly with its impact, as pointed out correctly by Bresnahan and Yanagawa in their comments.
448 ARIGA, OHKUSA, AND NISHIMURA

APPENDIX B: DATA CONSTRUCTION

This appendix briefly explains the procedure used to obtain the variables in the
empirical analysis of the text.
Capital stock K. The firm’s capital stock includes equipment and structure,
but excludes land holdings. We excluded land because of the huge discrepancy be-
tween the market price and the book value of the land. In Japan, in filing the official
balance sheet, public firms can use either the acquisition value or the replacement
cost as the book value for most fixed assets. Virtually all firms use the original ac-
quisition value, and there is no established way to correct for the discrepancy. This
discrepancy also exists for equipment and structures. To minimize the problem,
we employed the following procedure. First, the starting-year stock is constructed
by deflating the book value of the capital stock in that year by the Wholesale Price
Index for Capital Goods of the Bank of Japan, Keizai Toukei Nenpo. Starting from
this year, the subsequent series of the capital stock is constructed by using the
perpetual inventory method in which the Wholesale Price Index of capital goods
is used as a deflator of investment.
Current output Q and normal output Q∗ . The real sales of the firm are used as
a proxy for the firm’s output. They are obtained by deflating its total sales by the
Overall Wholesale Price Index. The normal output is then the trend for real sales
of the firm. It is simply a fitted value of the regression of real sales on time and a
constant, in which no higher order terms are included.
Rental price r of the capital stock. We use the following formula to correct for
corporate tax, depreciation allowance, and capital gains from inflation in capital
goods:

¡ ¢ 1 − k − τd
r = ρ + dep. − π Ke × pK .
1−τ

Here, r is the firm’s rental price of capital, ρ is the firm’s real cost of funds, dep.
is the economic rate of depreciation, π Ke is the expected rate of inflation of capital
goods, p K is the real price of capital goods, k is the effective rate of investment
tax credit (=0 in Japan), τ is the effective rate of corporate income tax, and d is
the present discounted value of tax deductions for depreciation.
The effective corporate tax rate is computed as

τ = (u + v)(1 + ρ)/(1 + ρ + v) where u = u c (1 + u ` ),

in which u is the overall corporate income tax rate, u c is the national corporate
income tax rate, u ` is the local corporate tax surcharge rate, and v is the enterprise
tax rate (=12%).
We used the following data for each of the variables above: ρ is the prime bank
lending rate; p K is the capital goods price index (a part of wholesale price indices);
 INDIVIDUAL-FIRM MARKUP IN JAPAN 449
dep., d, u c , and u ` are data taken from an unpublished work by Nishimura and
Shirai. The last group of data are annual and are for dep. and d. Nishimura and
Shirai estimate these values for each industry. All of these data are available from
the authors upon request.
Labor’s share α L . The ratio of total employment compensation to the total
sales.
Capital’s share α K . The ratio of r K to the total sales.
Raw material’s share. The ratio is computed as the sum of total purchases in
materials, intermediate goods, and utility expenses minus the increase in inventory
of materials and intermediate goods.
Cash flow/asset ratio CFAS. This ratio is the sum of the operating profits,
the depreciation allowance adjusted for investment outlay on tangible fixed assets
except for land, divided by the value of the firm’s asset.

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