Author Archives: Benjamin Chris Zissimos

Making Globalization More Inclusive

Posted on by

Making Globalization More Inclusive:

Lessons from experience with adjustment policies

Edited by Marc Bacchetta (WTO and University of Neuchâtel), Emmanuel Milet (Geneva School of Economics and Management) and José-Antonio Monteiro (WTO and University of Neuchâtel)

Policies aimed at helping workers adjust to the impact of trade or technological changes can provide a helping hand to the workforce and increase the benefits of open trade and new technologies. This publication contributes to the discussion on how governments can help make international trade more inclusive and ensure that the benefits of open trade are spread more widely.

Click here for further details and to download a copy of the book

Office-Selling, Corruption, and Long-Term Development in Peru

Posted on by

By Jenny Guardado (Georgetown University)

The idea that colonial institutions are fundamental in explaining the divergent development trajectories of New World countries is well-established.[1] In this view, colonial institutions led to longstanding differences in the protection of property rights or the provision of public goods in countries such as the US and Canada on the one hand and a number of Latin American countries on the other, affecting economic growth.[2] Yet, some of the most damaging economic consequences of colonialism also came from individuals’ intent on extraction for self-enrichment purposes, even within the same institutional framework.  For instance, in Spanish America, the figure of corregidor or provincial governor, is associated with some of the worst abuses committed against the indigenous population.[3] For this reason, it is important to look into the selection and quality of colonial officials as a key mechanism to understand long-run economic divergence, while holding the type of colonial institutions constant.

In a recent paper, I do precisely that.[4] Relying on a unique market for colonial offices in the seventeenth and eighteenth century Spanish Empire, I show that at least part of the impact of colonialism can be explained by their role in attracting certain types of individuals to serve in the colonial government. To do so, I collected an original dataset of the prices paid for provincial governorships (corregidores) between 1670 and 1750 to distinguish individuals seeking office for extractive purposes and investigate their long-run impact on economic development within Peru. As a market-based measure of profitability, office prices offer a unique opportunity to distinguish empirically which positions had higher returns to extraction. Furthermore, to avoid concerns of the Crown selectively timing sales when prices are high, I always compare prices at times in which Spain is involved in European Wars – thus less selective and more fiscally pressured – across provinces that only vary in the potential for extraction.  Figure 1 below shows the geographical distribution of the provinces’ prices paid between 1670 and 1750, mapped onto current boundaries in Peru.

Figure 1. Current Districts and Office Prices

Results show that office prices were much higher at times in which the Crown relaxed its selection criteria —during fiscal crises caused by European wars—in provinces with greater potential for profit vis-a-vis others. On average, prices were 16% higher in provinces with greater potential to profit from a key extractive activity (known as repartimiento or the forced sales of goods at markup prices) relative to others. This result translates into more than three times the yearly wage of a military captain in the Spanish army at the time. Alternative explanations such as prices reflecting changes in the attractiveness of Peruvian provinces during European wars, or selectivity in sales by the Crown, among others, are not borne out in the data.

Rather, additional analyses using individual buyers’ traits show that provinces with greater opportunities for extraction were more likely to be purchased by “worse” individuals – particularly when the Crown was less selective. In other words, individuals of lower social status, less bound by social and reputation costs, were more likely to pay higher prices to purchase positions with greater returns to extraction. Because social capital and reputation were key mechanisms to enforce compliance with the Crown’s interests in 18th century Spain, these individuals were of plausibly lower quality than those whose career (e.g. military) or social capital (e.g. nobility) were easier to monitor and screen by the Crown. In this sense, office selling allowed a relatively “worse” class of official to rule in the Spanish Empire. Although the practice ended formally in 1750, by then the Crown had sold so many appointments in advance, that buyers were still ruling Peruvian provinces well into the 1770s – on the eve of the nineteenth century independence movements.

The next question is: did the rule by these individuals influence the long-run economic prospects of these provinces? The answer is yes.  Estimates show that a larger gap or difference in office prices at times of low oversight (during wars) relative to periods of high oversight (during peace) is associated with lower household consumption, years of schooling and public good provision. Because province fundamentals – that may influence long-run development – do not vary between war and peace times in Europe, price differences likely capture shifts in the selectivity criteria of the Crown due to fiscal considerations and not other factors. Figure 2 below shows the relationship between the gap in office prices and household consumption.  Importantly, this economic gap is already present in 1827 — just after Peru gained independence—suggesting the importance of colonial rather than postcolonial factors.

Figure 2. Office Prices Differences and HH Consumption

Each scatter dot represents the mean of the outcome of interest within each bin plotted against the mean value of the difference in office prices within each bin. The solid line shows the best linear fit using OLS.

One important reason why we observe these effects today is because extraction during this period led to spontaneous rebellions which were usually brutally put down. Detailed data on local rebellions for eighteenth century Peru show that provinces with higher prices paid during European wars relative to peace times experience a higher number of spontaneous uprisings against their colonial rulers in the office-selling period (1673–1751) than immediately afterwards (1752–1780). Furthermore, this relationship is still visible in recent times: districts with higher prices in the seventeenth and eighteenth centuries also exhibit greater initial support for anti-government Maoist guerrillas (Shining Path) in the 1980s.

Similarly, political violence also led the indigenous population to limit intentionally its interactions with the Spanish and mestizo world. Data from two centuries show that in provinces with higher provinces the ethnic segregation of the indigenous population started to become visible post office-selling (1780), worsened in the nineteenth century (1876), and is even higher in contemporary times (2013). While limiting interactions may have served to “protect” the community, it might have also reduced the gains from participating in the market.

Put together, these results show the importance of appointment mechanisms and the quality of colonial officers to understand the impact of colonialism on economic development, even for cases sharing the same institutional framework.

References

Acemoglu, D., Johnson, S., & Robinson, J. A. (2001); “The Colonial Origins of Comparative Development: An Empirical Investigation. American economic review, 91(5), 1369-1401.

Banerjee, A., & Iyer, L. (2005); “History, Institutions, and Economic Performance: The Legacy of Colonial Land Tenure Systems in India.” American economic review, 95(4), 1190-1213.

Dell, M. (2010); “The Persistent Effects of Peru’s Mining Mita.” Econometrica, 78(6), 1863-1903.

Engerman, S. L., & Sokoloff, K. L. (1997); “Factor Endowments, Institutions, and Differential Paths of Growth Among New World Economies.” How Latin America Fell Behind, 260-304.

Guardado, J. (2018); “Office-Selling, Corruption, and Long-Term Development in Peru.” American Political Science Review, 112(4): 971–995.

Juan, J. (1826). Noticias Secretas de América, Sobre el Estado Naval, Militar, y Politico de Los Reynos del Perú y Provincias de Quito, Costas de Nueva Granada y Chile. (Vol. 2). Taylor.

Moreno Cebrián, A. (1977); El Corregidor de Indios y La Economía Peruana del Siglo XVIII: Los Pepartos Forzosos de Mercancias. Editorial CSIC-CSIC Press.

Endnotes

[1] Engerman and Sokoloff (1997) and Acemoglu, Johnson and Robinson (2001).

[2] Banerjee and Iyer (2005) and Dell (2010).

[3] Juan (1826) and Moreno Cebrián (1977).

[4] Guardado (2018).

Price, Product Quality, and Exporter Dynamics: Evidence from China

Posted on by

By Joel Rodrigue (Vanderbilt University) and Yong Tan (Nanjing University of Finance and Economics)

For the typical Chinese exporter, foreign sales grew exponentially after China’s entry to the WTO.  How was this so-called ‘economic miracle’ achieved in such a short span of time? Answering this question has been the focus of policymakers, government officials, and academic researchers across the globe.

Our recent paper adds to a rich literature studying the determinants of Chinese export growth.[1] In particular, we examine the impact that consumer loyalty has on the market strategies adopted by Chinese firms to successfully grow into high-value export markets.  Even if they were aided by falling trade costs, convincing foreign consumers to purchase Chinese goods for the first time is no small feat.  To clear this hurdle we argue that Chinese firms systematically chose to enter markets producing low quality products and setting low prices.

This doesn’t mean the stereotype that Chinese exports are broadly low price or low quality is accurate.  Rather, as foreign consumers adopted new Chinese goods, producers adjusted production to produce higher quality, higher price, higher-value varieties.  In this sense, the rapid Chinese export-driven economic growth has occurred alongside an observable rise in the nation’s firm-level climb up the value-chain.

Our approach builds on the static O-ring models of endogenous quality choice under monopolistic competition.[2]  We extend this setting to consider the dynamic pricing and product quality decisions by bridging this framework with models of habit persistence and demand accumulation.[3]  A key outcome from this marriage of ideas is that exporting firms will alter markups and product quality over time in order to grow sales rapidly during the initial years after entry and develop a large customer base.

The degree to which firms care about the future, however, depends on the firm’s long-run outlook in competitive export markets.  Small, unproductive firms are more likely to produce low quality products and yield little discount initially because they don’t expect to serve the same consumers more than once.  In contrast, the most efficient firms optimally aim to reach consumers by offering good value for their dollar: high quality products at a relatively low price.

To fix ideas we focus on the production of electric kettles, a small electronic appliance, typical of much of China’s export growth.  In Figure 1 we depict the evolution of export prices, product quality and export sales for a representative firm in a typical export market.  New Chinese exporters, despite producing low quality varieties, sell these goods one percent cheaper than established firms selling the same quality of electric kettle.  While this difference might sound small, it is worth at least 4 percent higher export sales in the firm’s first year – often the difference between breaking even or losing money when a firm enters new markets.

Over time the impacts are even larger.  While the export sales of a typical kettle producer grew by nearly 80 percent between 2001 and 2006, Chinese producers systematically added new features to their products: stainless steel casings, rapid heating systems, larger capacity, etc.  Adding these desirable product characteristics, however, is not free.  Rather, we document that over a five-year period typical input costs rose by twelve percent to incorporate higher quality attributes.

Not surprisingly product quality upgrading is likewise found to drive a large part of Chinese export growth; observed product improvements account for at least 17 percent of the aggregate growth in kettle exports over the same time period. As Chinese firms further entrenched themselves in foreign export markets, their profits rose accordingly: markups increased by nearly 2 percent over the same time period as Chinese firms exported kettles at higher and higher profit margins.

The consequences for trade policy are manifold.  In particular, price effects are likely to be muted in response to changes in trade policy.  While tariff declines are found to directly reduce the price consumers pay, product quality upgrading has an opposing effect.  Quality upgrading offsets price declines because high quality products are more expensive to produce, but also because it induces higher producer markups.

In contrast to the long march towards free and unfettered trade after WWII, recent tariff policy can broadly be characterized by unprecedented tariff increases in many countries.  Nowhere is this more evident than US trade policy vis-à-vis China where tariffs have increased sharply, but – surprisingly – prices have remained remarkably stable despite the rise in trade costs.[4]  Could this reflect changes in product characteristics and markups?  That remains unclear.  What is clear is that Chinese producers will react to tariff change on multiple fronts to maintain and grow their foothold in US export markets.  Ignoring the multi-dimensional responses of producers can potentially misrepresent the nature and impact that tariff policy has on firm behavior.

References

Amiti, Mary, Stephen J. Redding, and David Weinstein, (2018); “The Impact of the 2018 Trade War on U.S. Prices and Welfare.’’ NBER Working Paper No. 25672.

Fajgelbaum, Pablo, Pinelopi Goldberg, Patrick Kennedy, and Amit Khandelwal, (2019); “The Return to Protectionism.” NBER Working Paper No. 25638.

Gilchrist, Simon, Raphael Schoenle, Jae. W. Sim, and Egon Zakrajsek, (2017); “Inflation Dynamics During the Financial Crisis.” American Economic Review, 107(3): 785-823.

Kugler, Maurice and Eric Verhoogen, (2012); “Prices, Plant Size, and Product Quality.” Review of Economic Studies, 79(1): 307-339.

Piveteau, Paul, (2018); “An Empirical Dynamic Model of Trade with Consumer Accumulation.” Working Paper, Columbia University.

Rodrigue, Joel and Yong Tan, (2019); “Price, Product Quality, and Exporter Dynamics: Evidence from China.” International Economic Review, forthcoming.

Endnotes

[1] Rodrigue and Tan (2019).

[2] See Kugler and Verhoogen (2012).

[3] In our model, habit persistence is based on Gilchrist et al (2017), while demand accumulation is based on Piveteau (2018).

[4] See Amiti et al (2018) and Fajgelbaum et al (2019).

Research Analyst

Posted on by

The Peterson Institute for International Economics, a leading think tank located at Dupont Circle, Washington, DC, seeks a full-time research analyst to work with Dr Chad P. Bown on projects on international trade policy and trade agreements.

Responsibilities include collecting and analyzing economic data, producing charts and graphs for publication and presentations, doing econometric analysis, reviewing policy texts, writing literature reviews, and summarizing results.

Applicants should have a solid understanding of international economics and policy, strong knowledge of econometrics, proficiency with Stata, good writing skills, and attention to detail. Applicants should also be self-driven and demonstrate professional maturity.

In addition to a resume and three references, applicants should also submit a recent writing sample.

The Institute offers a professional work environment, a competitive salary, and excellent benefits. Please email applications to  with the subject line “RA-International Trade Policy.” No phone calls please.

For more: https://www.piie.com/about/employment/full-time-research-analyst

Do Macro Production Functions Differ Across Countries?

Posted on by

Markus Eberhardt (University of Nottingham) and Francis Teal (Centre for the Study of African Economies, University of Oxford)

“We compare this [input] index with our output index and call any discrepancy ‘productivity’… It is a measure of our ignorance, of the unknown, and of the magnitude of the task that is still ahead of us.” Zvi Griliches (1961)

It is an unfortunate misconception that the canonical Solow-Swan growth model necessarily implies that all economies in the world, rich or poor, industrialised or agrarian, possess the same production technology.[1]  As the above quote shows there are prominent critics of this assumption while Solow himself suggested that “whether simple parameterizations do justice to real differences in the way the economic mechanism functions in one place or another” was certainly worth ‘grumbling’ about.[2] Nevertheless, the notion that cross-country empirical analysis should, in case of accounting exercises, adopt or, in case of regression analysis, aim to arrive at a common capital coefficient of around 0.3 for all countries is deeply ingrained in the minds of growth economists.

In a forthcoming paper, we take an alternative approach to revisit the issue of whether technology is common across countries.[3] But before we discuss the approach and findings of that paper, we want to briefly illustrate why the assumption of a common capital coefficient is questionable. If the commonly adopted value for the capital coefficient of 1/3 were of great significance then we would expect total factor productivity (TFP) estimates from standard growth accounting exercises to differ substantially once we chose different values for the capital coefficient, in particular for values close to zero. Our data exercises proceed as follows: we first draw a random capital coefficient between zero and one, which we employ to compute annual TFP growth via standard growth accounting. The accounted country-specific TFP growth is then averaged over time and countries are ranked by TFP growth magnitude. This process is then repeated 1,000 times.

An important feature of this analysis and also our study is the focus on manufacturing. The central importance of this industrial sector for successful development is (still) a widely recognised ‘stylised fact’ in development economics. Yet in contrast to the literature on cross-country growth regressions using aggregate economy or agriculture data there is comparatively little empirical work dedicated to the analysis of the manufacturing sector in a large cross-section of countries. If manufacturing matters for development it seems self-evidently important to learn about the production process and its drivers in this industrial sector.

A visual illustration of the results from the 1,000 growth accounting exercises is provided in Figure 1: the ‘Baobab trees of growth accounting’. We split the 48 countries in the sample into 8 groups, based on the rankings implied by their average TFP growth rate when the capital coefficient is 1/3. On the y-axis of each plot we indicate the capital coefficient applied in the growth accounting exercise, while the x-axis indicates the resulting rank of each country from 1 to 48 in terms of average TFP growth. All of the plots show the same pattern, resembling a Baobab tree, with a narrow ‘trunk’ and a spreading out of the upper ‘crown’. We conclude that provided the capital coefficient is assumed common across countries it is entirely unimportant what value is chosen for this parameter, since the productivity rankings based on TFP growth rates are essentially unchanged for ‘reasonable’ values of the capital coefficient. We only see considerable change if the capital coefficient is greater than 0.6, which we know is an unreasonable parameter value. This finding raises serious doubts over the validity of the common technology assumption maintained in these computations.

Figure 1

 

In our paper, we compare and contrast regression results from different estimators which make different assumptions about production technology and TFP: whether technology differs or is common across countries, whether TFP levels and growth rates differ or are common across countries. While the theoretical literatures on growth and econometrics provide solid foundations for technology heterogeneity as well as the time-series and cross-section properties of macro panel data we highlight in our paper, these have in practice not been considered in great detail in the empirical growth literature. Since most growth economists are not familiar with our preferred set of empirical estimators, we motivate and discuss them in the paper at great length. These methods enable us to model country-specific production technology and time-invariant unobserved heterogeneity across countries (differential TFP levels), but also time-variant unobserved heterogeneity to capture differential TFP evolution over time in a very flexible manner.

Our analysis establishes that assuming a common technology parameter for all countries yields very serious bias in the capital coefficient, with parameter values ranging from 0.6 to 0.8, far in excess of the macro evidence of 0.3. The heterogeneous parameter estimators yield uniformly lower capital coefficients, much more in line with the aggregate economy factor income share data. Based on formal diagnostic testing, our empirical results favour models with heterogeneous technology which account for a combination of heterogeneous and common TFP and reject the notion of common technology. We also carried out a significant number of formal parameter heterogeneity tests which confirmed this result.

Our general production function framework provides a number of alternative insights into macro TFP estimation. Firstly, it seems prudent to allow for maximum flexibility in the structure of the empirical TFP terms: if TFP represents a ‘measure of our ignorance’ then it makes sense to allow for differential TFP across countries and time. Secondly, it further makes sense to keep an open mind about the commonality of TFP: while early empirical models assumed common TFP growth for all countries, later studies preferred to specify differential TFP evolution across countries. We believe the arguments for commonality (non-rival nature of knowledge, spillovers, global shocks) and idiosyncracy (patents, tacit knowledge, learning-by-doing) call for an empirical specification which does not rule out either by construction. Thirdly, an empirical specification that allows for parameter heterogeneity across countries and for a shift away from the widespread focus on TFP analysis and toward an integrated treatment of the production function in its entirety appears to fit the data best. The Baobab Tree accounting exercises illustrate the very limited insights to be gained from the assumption of a common technology framework.

Our analysis represents a step toward making cross-country empirics relevant to individual countries by moving away from empirical results that characterise the average country and toward a deeper understanding of the differences across countries. Further, the key to understanding cross-country differences in income is not exclusively linked to understanding TFP differences, but requires careful consideration of differences in production technology. Since modelling production technology as heterogeneous across countries requires an entirely different set of empirical methods we have focused on developing this aspect in the present paper and have left empirical testing of rival hypotheses about the patterns and sources of technological differences for future research.

References

Eberhardt, Markus, and Francis Teal (2019); “The Magnitude of the Task Ahead: Macro Implications of Heterogeneous Technology.” Forthcoming in the Review of Income and Wealth.

Griliches, Zvi, (1961); “Comment on An Appraisal of Long-Term Capital Estimates: Some Reference Notes by Daniel Creamer.” Output, Input, and Productivity Measurement (NBER), pp. 446–9.

Solow, Robert M., (1986); “Unemployment: Getting the Questions Right.” Economica, 53(210): S23–34.

Endnotes

[1] We refer to ‘technology heterogeneity’ to indicate differential production function parameters on observable inputs across countries, with unobservables captured as TFP.

[2] See Solow (1986 S23)

[3] See Eberhardt and Teal (2019)

Should the WTO Require Free Trade Agreements to Eliminate Internal Tariffs?

Posted on by

By Kamal Saggi (Vanderbilt University), Woan Foong Wong (University of Oregon), and Halis M. Yildiz (Ryerson University)

At a time when multilateral trade liberalization at the World Trade Organization (WTO) seems to have come to a grinding halt, preferential trade agreements (PTAs) appear to be the only game in town for countries interested in undertaking international trade liberalization. Under the current rules of the WTO, countries entering into a PTA are required to eliminate tariffs on “substantially all trade” with each other and refrain from raising trade restrictions on non-member countries. In the existing literature, Article XXIV has often been invoked as a justification for the assumption that PTA members impose zero tariffs on each other. Though reasonable, this approach masks the incentives underlying the tariff-setting behavior of PTA members and, by design, fails to shed light on the consequences of requiring them to fully liberalize internal trade. In reality, PTA members do not always abide by this restriction.[1] In a recent article, we employ a model of endogenous trade agreements to shed light on the consequences of such non-compliance on the part of PTA members regarding the free internal trade requirement of GATT Article XXIV.[2]

Our conceptual approach follows the recent literature on endogenous formation of trade agreements.[3] In a modified version of the three-country competing exporters framework, in order to draw out the implications of requiring PTA members to eliminate tariffs on one another, we derive and contrast optimal tariffs and equilibrium trade agreements under two scenarios.[4] While members are required to engage in free internal trade in the WTO-consistent scenario, PTA members have the freedom to implement jointly optimal internal tariffs under the unconstrained preferential liberalization scenario. A comparison of these two scenarios delivers several interesting results.

First, we show that if FTA members choose internal tariffs to maximize their joint welfare, they indeed have an incentive to impose positive tariffs on one another. The intuition for this surprising result rests on the interplay between the lack of external tariff coordination between FTA members and the complementarity of imports tariffs. Since FTA members set their external tariffs independently, each member fails to take into account the benefits that its external tariff confers on its partner and thus the individually optimal external tariffs of FTA members are too low from the perspective of maximizing their joint welfare. While coordinating their internal tariffs, FTA members deliberately choose to set positive internal tariffs on each other: doing so commits each of them to a higher external tariff on the non-member country thereby bringing their individually optimal external tariffs closer to jointly optimal ones. To confirm the role that external tariff coordination plays in generating positive internal tariffs within an FTA, we consider a CU formation game where members can coordinate their external as well as internal tariffs. Under such a case, members indeed find it optimal to engage in free internal trade. This result suggests that the free internal trade requirement of Article XXIV is likely to be more binding for FTAs relative to CUs.

The second major insight delivered by our analysis is that requiring PTA members to eliminate internal tariffs benefits the non-member since it leads to lower external tariffs on the part of PTA members. This result is noteworthy since part of the original intent behind the design of Article XXIV may have been to minimize any potential negative effects of PTAs on non-member countries. Ostensibly, this objective was met by prohibiting PTA members from raising their external tariffs on outsiders. However, in our model, PTA members have no incentive to increase their external tariffs on the non-member country anyway. Thus, the Article XXIV stipulation that PTA members cannot raise tariffs on outsiders may actually do little to protect the interests of outsiders. Our analysis demonstrates that, somewhat surprisingly, it is the Article XXIV requirement of free internal trade within a PTA that ends up protecting the non-member as opposed to the restriction imposed on the external tariffs of PTAs.

Our third major result pertaining to the free internal trade requirement of Article XXIV is that having such a requirement makes it harder to achieve global free trade. By lowering the external tariffs of FTA members, the free internal trade requirement of Article XXIV makes it less attractive for the non-member to enter into trade agreements with them. Thus, the free internal trade requirement of Article XXIV might facilitate some degree of free-riding in the WTO system by allowing non-member countries to benefit from reductions in external tariffs of FTA members (that result from their internal trade liberalization) without having to offer any tariff cuts of their own. Thus, our overall message is somewhat nuanced: when circumstances are such that achieving global free trade is not possible, the free internal trade requirement of Article XXIV increases world welfare by lowering tariffs worldwide but, at the same time, it also reduces the likelihood of reaching global free trade.

We also show that our results are robust to two alternative tariff setting scenarios. First, we relax the assumption that countries seeking to form FTAs set their MFN tariffs non-cooperatively. To this end, we allow countries to engage in a limited degree of cooperation and show that our main results regarding the impact of the free internal trade requirement continue to hold even when countries do not set their tariffs in a fully non-cooperative manner. Second, to address the issue of the extent of enforceability of the free internal trade provision of Article XXIV, we examine a scenario where Article XXIV imposes a ceiling on the internal tariffs of an FTA. Under such a scenario, we show that the free-riding incentive continues to be the pivotal force and tighter ceiling lowers the external tariffs of FTA members, making it less attractive for the non-member to enter into trade agreements with FTA members which in turn undermines global free trade.

References

Bagwell, K. and R.W. Staiger, (1999); “Regionalism and multilateral tariff cooperation.” In John Piggott and Allan Woodland, eds, International Trade Policy and the Pacific Rim, London: MacMillan.

Bagwell, K., C.P. Bown, and R.W. Staiger, (2016); “Is the WTO passé?” Journal of Economic Literature 54(4): 1125-1231.

Saggi, K. and H.M. Yildiz, (2010); “Bilateralism, multilateralism, and the quest for global free trade.” Journal of International Economics 81: 26-37.

Saggi, K., W.-F. Wong and H.M. Yildiz, (2019); “Should the WTO require free trade agreements to eliminate internal tariffs? “, Journal of International Economics, 118, 316-30, 2019.

Saggi, K., A. Woodland, and H.M. Yildiz, (2013); “On the relationship between preferential and multilateral trade liberalization: the case of customs unions.” American Economic Journal: Microeconomics 5(1): 63-99.

Endnotes

[1] See Bagwell et. al, 2016.

[2] See Saggi et al. (2019).

[3] See Saggi and Yildiz (2010) for FTAs and Saggi et. al (2013) for CUs.

[4] See Bagwell and Staiger (1999).

Welcome New Members May 2019

Posted on by

We would like to welcome the following new members to the InsTED Network

Prof Kathy Baylis (University of Illinois at Urbana-Champaign) Her research interests lie in the design of agricultural, conservation, and trade policy to promote ecosystem preservation and international food security.

Ms Casey Petroff (Harvard University).  Her research interests are in economic development and public policy, focusing on the development of public good provision relating to health care.

Economic Shocks and Crime: Evidence from the Brazilian Trade Liberalization

Posted on by

By Rafael Dix-Carneiro (Duke University), Rodrigo R. Soares (Columbia University), and Gabriel Ulyssea (University of Oxford)

The idea that economic crises can lead to increased crime is far from new, dating back at least to the Great Depression of the 1930s.[1] Such concern is well justified, as crime imposes a substantial welfare cost on society. However, estimating the causal effect of economic conditions on crime and quantifying this relationship has proven to be elusive. Indeed, finding an exogenous variation in economic conditions is quite challenging and there are different potential threats to identification, such as omitted variable bias and reverse causality.[2]

In a recent paper, we overcome these challenges by exploiting the Brazilian trade liberalization of the 1990s, which provides a natural experiment that generated exogenous shocks to local economies in the country.[3] Brazil is a particularly appealing empirical setting, as there is little evidence on the effect of economic conditions on crime in developing countries with a high incidence of crime. In 2013, Brazil was ranked first worldwide in absolute number of homicides (more than 50,000 occurrences per year) and 14th in homicide rates, with 25.2 homicides per 100,000 inhabitants.[4] However, the country is not an outlier within Latin America and the Caribbean: according to the UNODC, 14 of the 20 most violent countries in the world are located in the region. Besides high incidence of crime, these countries also have in common poor labor market conditions, weak educational systems, and high levels of inequality. In such context, adverse economic shocks can have more severe effects on crime, with potentially larger welfare implications.

In our empirical design, we follow the previous literature[5] and exploit two features of the Brazilian context. First, the trade liberalization episode was not only characterized by large tariff reductions – which fell from 30.5% to 12.8% between 1990 and 1994 – but there was also substantial variation in the intensity of tariff cuts across industries. Second, regions in Brazil have very different economic structures and specialize in the production of different baskets of goods. The combination of these two features therefore implies that the trade liberalization leads to very different levels of exposure to foreign competition across regions. For example, Traipu in the state of Alagoas was largely specialized in agriculture, which actually experienced a slight increase in the level of protection (i.e. tariffs). In contrast, Rio de Janeiro specialized in apparel and food processing, both of which experienced substantial tariff reductions. Thus, one could expect Rio de Janeiro to be more adversely affected by the trade opening than Traipu. This reasoning provides the base for our empirical approach, which exploits this exogenous variation in exposure to the trade shock across regions.

We show that regions more exposed to the trade shock – i.e. more specialized in industries facing larger tariff reductions – experienced a relative increase in the number of homicides in the years immediately after the end of the trade liberalization, but the effect completely vanishes in the long run. This can be seen in Figure 1, which shows the differential increase in the logarithm of crime rates in regions facing larger reductions in tariffs relative to regions that experienced lower tariff reductions. This large effect contrasts with those found in the previous literature, which typically shows that worse economic conditions are associated to higher property crime, but find no effects on homicides. However, previous studies have focused on developed countries (Mustard 2010), which have relatively low crime rates and stronger baseline economic conditions (i.e. lower inequality and better functioning labor markets).

Figure 1 Effect of Trade liberalization on Regional Homicide Rates

 

Having established the overall effect of the trade shock on crime, we use the dynamics of this effect to directly investigate its potential channels. We show that the trade shock substantially affected different potential determinants of crime, such as labor market conditions, public goods provision (public safety and government spending), and income inequality. However, only the effect on labor market conditions (as measured by employment rates) follows the same dynamic pattern as the effect of the trade shocks on crime. Importantly, these two dynamic responses are very different from those observed for other potential determinants, such as public goods provision and inequality. This strongly indicates that the employment rate is the key channel to explain how these local trade shocks affected crime. In the paper, we develop an econometric framework that exploits these different dynamic responses to identify lower and upper bounds for the effect of labor market conditions on crime. We find that employment rates accounted for 75–93% of the observed effect of the trade shocks on crime.

In sum, our results highlight that crime is an important dimension of the adjustment costs to trade shocks. Hence, to the extent that trade opening leads to transitional unemployment, there can be substantial externalities associated to this adjustment process in the form of temporarily higher crime rates. Moreover, our results indicate that employment rates are the key mediating channel of the overall effect of trade opening on crime.

Interestingly, earlier research shows that the long-run employment recovery in Brazil occurred exclusively via informal employment, as formal employment does not recover even 20 years after the trade opening episode.[vi] These results therefore suggest that informal jobs were crucial in keeping individuals away from criminal activities, despite the fact that they might be of lower quality when compared to those in the formal sector. If this is indeed the case, stricter enforcement of labor regulations could exacerbate the response of crime to adverse economic shocks. Put differently, our results suggest that more lax enforcement of labor regulations – and active labor market policies – may help to prevent increases in crime during economic downturns.

References

Dix-Carneiro, R., R. Soares and G. Ulyssea (2018); “Economic Shocks and Crime: Evidence from the Brazilian Trade Liberalization.” American Economic Journal: Applied Economics, 10(4), 158-95.

Dix-Carneiro, R., and B. Kovak (2017a); “Trade Liberalization and Regional Dynamics.” American Economic Review, 107(10), 2908-46.

Dix-Carneiro, R., and B. Kovak (2017b); “Margins of Labor Market Adjustment to Trade.” Journal of International Economics, 117, 125-142.

Fishback, P.V., R.S. Johnson, and S. Kantor (2010); “Striking at the Roots of Crime: The Impact of Welfare Spending on Crime During the Great Depression.” Journal of Law and Economics, 53(4): 715-740

King, L (2009); “Statistics Point to Increase in Crime During Recessions [5]”, The Virginia Pilot, 19 January.

Mustard, D B (2010); “How do Labor Markets Affect Crime? New Evidence on an Old Puzzle.” Published in B Benson and P Zimmerman (eds), Handbook on the Economics of Crime, Edward Elgar, Chapter 14: 342–358.

UNODC (2013); “Global Study on Homicide [7]”, United Nations Office on Drugs and Crime.

Endnotes

[1]  See e.g. Fishback, Johnson and Kantor (2010).

[2] Mustard (2010).

[3] Dix-Carneiro, Soares and Ulysssea (2018).

[4] UNODC (2013).

[5] See Dix-Carneiro and Kovak (2017a, b).

[6] Dix-Carneiro and Kovak (2017b).

The Impact of TRIPS and Compulsory Licensing on Developing Country Markets

Posted on by

By Eric Bond (Vanderbilt University) and Kamal Saggi (Vanderbilt University)

The Trade-Related Intellectual Property Rights (TRIPS) agreement of the World Trade Organization (WTO) requires that all WTO members provide a minimum level of patent protection for all types of intellectual property. This requirement has created a problem for developing countries in obtaining access to patented pharmaceuticals, because pharmaceutical companies are reluctant to sell drugs in middle and lower income countries due to the potential negative impact on prices in high income markets. The spillovers can result from the use of reference pricing in high income markets, whereby a high income country government uses an average of prices in other countries to determine the price that a patent holder can charge in its market.  Spillovers can also arise from illegal arbitrage trade.[1]

As a result of these potential spillovers, newly patented drugs may be unavailable or introduced with substantial delays in middle and low income markets.[2] TRIPS does, however, provide countries with the option of issuing a compulsory license (CL) if the market has not been served in a reasonable period of time. A country issuing a CL is required to provide adequate compensation to the patent holder. There have been a number of examples of the use of CLs to obtain access to patented pharmaceuticals by middle and low income countries since the advent of TRIPS, including drugs to treat AIDS, heart disease, and cancer.[3]

How does the requirement of patent protection under TRIPS, combined with the option of issuing a CL if the market isn’t served, affect the welfare of developing countries and patent holders? In a recent article, we address this question using a game-theoretic model to consider a patent holder’s decision of whether it should incur the fixed cost of entering a developing country market.[4] We show how the answer to this question depends on the imitative ability of the developing country to produce copies of the patented product and the level of fixed costs of entry relative to the profits from the market.

Prior to TRIPS, a developing country could obtain copies of patented products from imitators if it did not provide patent protection.  For countries where the cost of entry for the patent holder was high relative to the profits from entry, typically countries with relatively small markets, the patent holders would only enter if patent protection was provided. The country would then have to choose between providing patent protection and obtaining a high cost, high quality product, or not providing patent protection and obtaining a low quality and low cost imitation. The high entry cost countries would only provide patent protection if the quality of imitators was sufficiently low.

In contrast, for countries where the fixed costs were low relative to the profits from entry, the patent holder might still be willing to enter without patent protection if the quality of the imitators was not too high. These countries obtained a double benefit by not providing patent protection: the patented product was obtained at a low price and the copies were also available for those unwilling to pay the price for patented goods.

The absence of patent protection prior to TRIPS made CLs an unnecessary instrument for developing countries, because imitators could produce patented foreign products without requiring a license.  In fact, we show that the option of using a CL could actually make all parties worse off by reducing the incentive of developing countries to offer patent protection. The insight is that developing countries are better off under imitation relative to a CL and therefore have an incentive to preempt the possibility of the patent-holder resorting to a CL by not recognizing the patent. After all, the issuance of a CL is premised on the legal recognition of the underlying patent.

The TRIPS requirement that developing countries provide patent protection made developing countries worse off and patent-holders better off, because it raised prices of patented products by preventing imitators from providing competition for patent holders. The extent to which the option of a CL mitigates the loss to the developing countries from TRIPS depends on the country’s characteristics. For countries with markets sufficiently profitable that the patent-holder would have entered without a patent, TRIPS primarily benefitted patent-holders by eliminating competition from imitators. For countries that would have had to rely on imitators to provide the product prior to TRIPS, TRIPS provides access to the product through a CL. However, the delay required before a CL can be issued means that the country will not obtain access to a copy of the patented product as quickly as it would pre-TRIPS.

Finally, the fact that the patent holder obtains a royalty payment under the CL means that it might prefer a CL to entry if the return from entry is sufficiently low. Thus, the option of a CL could actually cause countries that provided patent protection pre-TRIPS to experience delay in obtaining access to the patented product under TRIPS. It should be noted that since developing countries do not take into account the profits of patent holders in making their decision whether to provide patent protection, the level of protection was below the socially optimal level pre-TRIPS.

We also consider the case in which the government of the developing country negotiates a price ceiling for which the patented product is to be sold in its market. The effect of the CL in this case depends on the relative bargaining power of the two parties during negotiations over the price ceiling. If the patent-holder has all of the bargaining power, then the government is able to use the threat of a CL to lower the price of the patented product. If the country has all of the bargaining power, the royalty payment required by TRIPS benefits the patent-holder by providing a minimum level of compensation that it must receive for entering the market. Thus, the ability to issue a CL primarily benefits the party whose bargaining position during price negotiations is relatively weaker.

References

Beall, R. and R. Kuhn, (2012); “Trends in Compulsory Licensing of Pharmaceuticals since the Doha Declaration: A Database Analysis.” PLos Medicine 9(1): 1-9.

Bond, E. W., and K. Saggi, (2018); “Compulsory Licensing and Patent Protection: A North-South Perspective.” Economic Journal 128 (May): 1157-79.

Cockburn, I.M., Lanjouw, J.O., and M. Schankerman, (2016). “Patents and the Global Diffusion of New Drugs.” American Economic Review 106(1): 136-164.

Danzon, P., Y. R. Wang, and L. Wang, (2005); “The Impact of Price Regulation on the Launch Delay of New Drugs,” Journal of Health Economics 14: 269-92.

Goldberg, P. K., (2010); “Intellectual Property Rights Protection in Developing Countries: The Case of Pharmaceuticals.” Journal of the European Economic Association 8: 326-53.

Endnotes

[1] See Golderg (2010).

[2] See Danzon, Wang, and Wang (2005), and Cockburn, Lanjouw, and Schankerman (2016).

[3] See Beall, R. and Kuhn, R. (2012).

[4] See Bond and Saggi (2018).