Making Globalization More Inclusive

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

Do Macro Production Functions Differ Across Countries?

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.


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.


[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)

Financial Constraints, Institutions and Foreign Ownership

Ron Alquist, (AQR Capital Management), Nicolas Berman (Aix-Marseille University), Rahul Muhkerjee (Graduate Institute, Geneva), and Linda L. Tesar (University of Michigan)

Cross border mergers and acquisitions (CBMA) as a form of foreign direct investment (FDI) by multinational corporations (MNCs) have grown rapidly in the last two decades. For emerging market economies (EMEs) in particular, the number of CBMA, mostly by firms from developed markets, grew at an average annual rate of 14.5% during 1990-2014. While the determinants of the volumes of these flows are well studied, relatively little is known about what drives MNC ownership structure choices when acquiring EME firms. Yet, existing research has established that the extent of foreign ownership is an important determinant of a number of outcomes that have traditionally motivated policy makers to encourage FDI.  These include post-investment changes in labor productivity, wages, or export participation, and spillovers through technology transfer to subsidiaries.[1] In a forthcoming article, we set out to study the underlying determinants of FDI ownership structure in a broad set of EMEs.[2]

In a nutshell, our main argument is as follows.  Acquiring firms in EMEs entails both benefits and costs for MNCs from developed nations. Among the benefits, MNCs may have superior access to funding that they can use to relieve financial constraints of target firms, thus increasing the profitability of the acquired firm. At the same time, these acquisitions come with costs inflicted by weak local institutions, since operating firms in EMEs involves sourcing local inputs in an unfamiliar environment with insecure property rights and distortionary policies. So, how do MNCs deal with these competing forces? We show in our paper that an MNC’s choice of ownership structure is critical in balancing the aforementioned benefits and costs. To this end we develop a theoretical model that emphasizes the role of finance and institutions, and that delivers predictions about the optimal degree of foreign ownership, which we then take to the data.

To highlight the trade-offs facing a foreign acquirer, our theoretical model postulates that production in EMEs requires capital and a local input. The foreign acquirer solves for an optimal ownership contract between itself and the domestic target firm that captures its advantage in having greater access to capital markets relative to the credit-constrained target, and the potential disadvantages of operating a firm in an EME. The MNC’s disadvantage compared to local firms, which is due to weaker institutions, is modeled as a markup on local inputs that is paid only by an MNC. The markup thus incentivizes operating the firm with a local co-owner. The MNC then faces a choice between obtaining full control of the credit-constrained target, in which case it is compelled to pay a higher price for the local input, or to take partial ownership, in which case the domestic equity owner can provide the local input at a lower price.

Three distinctive sets of predictions emerge from the model. The first and second pertain to the ownership structure chosen by an MNC. Full (relative to partial) foreign ownership of targets is predicted to be more likely in sectors that have a greater dependence on external finance, and in countries that are less financially developed, while better institutions are found to tilt the scales towards full ownership. The effects of institutions and financial development are also predicted to be the largest for the sectors of the economy most dependent on external finance. The second set of predictions pertains to partial ownership. Here the model predicts that financial factors should play a weaker role in determining the precise size of partial stakes, while the input price markup is predicted not to influence the ownership structure in partial acquisitions at all. Our final predictions, which relate to the overall likelihood of foreign acquisitions, are that foreign acquisitions are more likely in sectors that have a greater dependence on external finance, in countries where financial markets are less developed, and when institutions are better.

We test these theoretical predictions in a large panel of CBMA transactions by developed market firms in fourteen EMEs over the period 1990-2007. We use the measure of sectoral external finance dependence due to Rajan and Zingales and country-level credit-GDP ratios as our main financial indicators, and anti-corruption indices as our baseline measure of institutional quality.[3]

The regression evidence confirms the main predictions of the model. The estimated effects are also quantitatively large. For example, the likelihood of an MNC choosing to own a domestic firm fully versus partially is predicted to be:

  • 22 percentage points larger for the sector with the highest (professional and scientific equipment) versus the lowest (tobacco) level of dependence on external finance
  • 21 percentage points lower in the most (Indonesia) versus the least (Chile) corrupt country
  • 14 percentage points lower in the most (South Africa) versus the least (Peru) financially developed country

As per the model, while dependence on external finance has the strongest effect in financially underdeveloped countries, it ceases to matter when local financial development, measured by private credit over GDP, exceeds 70%. In the same vein, external finance matters roughly three times more in countries with the lowest levels of corruption than in the most corrupt countries.

Our model’s predictions concerning the effect of financial factors on the overall prevalence of cross border acquisitions across sectors and countries are also borne out by the data. For example, we find that moving from the sector that is most to least dependent on external finance raises the share of CBMA (among all acquisitions) by 22 percentage points. At the same time, the share of CBMA is predicted to be 27 percentage points lower in the most versus the least financially developed country.

Taken together, our theoretical model and empirical evidence show that the interaction of financial, institutional, and technological factors plays an important role in determining the pattern of foreign ownership in North-South FDI flows. It also throws light on a number of empirical features of CBMA across sectors and countries, for example, why full foreign acquisitions are seldom observed (roughly 19%)  in countries such as Thailand that have both developed financial markets and weak institutions.  Our results also point towards improvements in institutions as a way to encourage higher MNC equity participation. For example, according to our estimates, a country like China would experience a doubling in the share of full acquisitions if it were to improve its corruption situation to the levels of Chile.


Alquist, R., N. Berman, R. Mukherjee, and L.L. Tesar, (forthcoming); “Financial Constraints, Institutions, and Foreign Ownership.” To appear in Journal of International Economics, DOI:

Bircan, Çağatay, (2019); “Ownership Structure and Productivity of Multinationals.” Journal of International Economics 116 (2019): 125-143.

Havranek, T., and Z. Irsova, (2011); “Estimating Vertical Spillovers from FDI: Why Results Vary and What the True Effect is.” Journal of International Economics 85(2): 234-244.

Javorcik, B. S., and M. Spatareanu, (2008); “To Share or Not to Share: Does Local Participation Matter for Spillovers from Foreign Direct Investment?Journal of Development Economics 85(1-2): 194-217.

Rajan, R., and L. Zingales, (1998); “Financial Dependence and Growth.” American Economic Review 88.3 (1998): 559-86.


[1] See for example, Javorcik and Spatareanu (2008),  Havranek and Irsova (2011), and Bircan (2019).

[2] See Alquist, Berman, Mukherjee and Tesar (forthcoming).

[3] See Rajan and Zingales (1998).

Summary of the 5th InsTED Workshop at Syracuse University

We would like to thank The Department of Economics and the Maxwell School of Citizenship and Public Affairs, Syracuse University, for hosting and sponsoring the 5th InsTED Workshop.  We are also grateful for sponsorship and organizational support from the Moynihan Institute of Global Affairs, as well as sponsorship from the Program for the Advancement of Research on Conflict and Collaboration (PARCC) and the University of Exeter Business School.  The workshop took place at the Maxwell School from May 15th-16th 2018.  Special thanks go to Kristy Buzard and Devashish Mitra as joint chairs of the local organizing committee, and Juanita Horan for her extremely helpful interactions with everyone.

The program comprised of 18 papers ranging over four broad topics at the intersection of institutions, trade and economic development.  The first was global value chains, focusing on how they are determined at the firm level, and what their implications are for economic outcomes, especially in the developing world.  The second topic examined ongoing concerns about the implications of trade integration for income distribution, with emphasis on a developing country perspective.   The third concerned the interaction between trade integration or other institutional reform and resource allocation.  The fourth was on institutional constraints on international trade policy, including a look at the implications of restrictions imposed by the World Trade Organization.  There now follows a summary of all the papers presented at the workshop, organized under these four topic headings.  A bibliography, together with links to papers where available, is provided at the end.  Please note that for brevity the summary mentions presenters’ names but not those of their co-authors.  This information is contained in the bibliography.

Global Value Chains: Their Determinants and Implications

The spread of global value chains (GVCs) over the last thirty years or so has been a key new feature of the current wave of globalization, and important for the integration of developing countries into the world economy.  At the broadest level, the spread of GVCs has been facilitated by innovations in information and communication technology, the deepening of trade liberalization and ongoing reduction in transport costs, and political developments principally involving the fall of the iron curtain.  But in this globally more integrated environment, there is growing appreciation that firm-level decisions play a critical role in the determination of how global value chains actually form.  The outcome of these decisions has been characterized in terms of GVCs forming either as ‘spiders’, where a central ‘body’ imports inputs for assembly from various ‘legs’ that originate in different countries, or where a product is assembled sequentially along the length of a ‘snake’.  Such trade in intermediate inputs now accounts for 70% of global trade, spanning not just developed but developing countries as well.

The keynote address by Pol Antràs discussed his research project to model how firm-level extensive margin sourcing decisions are made, that give rise to the formation of GVCs.  His motivation of the need for a new model was that the canonical Melitz model renders firm export decisions tractable by assuming constant (exogenous) marginal costs, while firm import decisions are made specifically to lower marginal costs which are therefore endogenous.  The interdependence in a firm’s extensive margin import decisions complicates the firm’s problem considerably.  In the case of a spider, this involves a combinatorial problem with 2J possible choices, where J denotes the number of possible source countries.  In the case of a snake, the problem is similarly complex.

Antràs presented two papers, which provide tractable ways to model firm decisions in the cases of spiders and snakes respectively in ways that can be estimated structurally in the data.  In the case of spiders, the modelling approach is to apply an iterative algorithm that exploits complementarities in the decision of a firm to import from particular markets, and uses lattice theory to reduce the dimensionality of the firm’s optimal sourcing strategy problem.  The results show that while the ‘China shock’ resulted in an overall decline in domestic sourcing by US firms, the most productive firms actually increased domestic sourcing due to the cost savings derived through sourcing from China.  In the case of snakes, where the value chain is sequential, Antràs showed that the lead firm’s problem becomes one of solving the least cost path through a sequence of suppliers.  By applying a different algorithm the paper shows that, other things equal, it is optimal to locate relatively downstream stages of production in relatively central locations.  He then discussed counterfactual exercises that illustrate how changes in trade barriers affect the extent to which various countries participate in domestic, regional or global value chains, and traces the real income consequences of these changes.  Using this approach, substantial income gains are shown to arise from the increased participation of low-income countries in GVCs.

A key question motivating the literature on the extensive margins of trade is whether better firm performance gives rise to exporting or, conversely, exporting improves firm performance.  A particular form of this question is as follows: if offered the opportunity to export through a marketing arrangement in a developed country, can firms in developing countries upgrade the quality of the goods they produce and export, thereby increasing their incomes?  Rocco Macchiavello presented a paper on the case of the Nespresso sustainable quality program in Colombia.  The dataset constructed for the paper matches detailed administrative data on the universe of Colombian Coffee farmers with transaction-level data along three stages in the coffee chain, from the export gate to the farm gate.  Machiavello and his collaborators find that the program induced farmers to upgrade their coffee plantations, expand their farms as well as production, increase the quality of the coffee produced, and the loyalty of their marketing arrangement.  Most notably, a price premium of approximately 5-8% is fully transmitted along the supply chain, from the export gate to the farm gate, thereby bringing significant income gains to farmers in the developing world.  This paper therefore adds to the evidence supporting the view that gaining the opportunity to export can indeed enhance firm performance.

While GVCs can potentially increase incomes by creating cost advantages and quality improvements, there is widespread concern that cost advantages may be gained through lax environmental and labor regulation in countries where suppliers are located.  Sebastian Krautheim presented a paper studying this issue both theoretically and empirically.  In the model of his paper, a Northern firm can save costs by outsourcing to a Southern supplier that uses a cost-saving but unethical technology.  Contracts are incomplete, so that a firm has limited control over unethical technology choices of suppliers along the value chain.  The technology is a credence characteristic, in that consumers care about it but cannot know what it is.  However, the model features a non-governmental organization (NGO) that can reveal the technology being used.  Using the unethical technology creates an incentive to increase scale, but this also increases the probability of being detected by the NGO.  The paper provides empirical support for the model’s prediction that a high cost advantage of ‘unethical’ production in an industry and a low regulatory stringency in the supplier’s country favor international outsourcing as opposed to vertical FDI.

Trade Integration and Income Distribution

There has long been a concern that deeper trade integration causes an increase in inequality.  This is the focus of the famous Stolper-Samuelson Theorem, which arises directly from the classic Hecksher-Ohlin model and in a wider set of settings as well.  It predicts that if, compared to the South, skilled labor is relatively abundant in the North while unskilled labor is relatively scarce, then deeper trade integration will drive an increase in inequality in the North and a decrease in the South.  Previous academic debates tended to focus on the rise in inequality in the North, and the extent to which trade integration with the South was ‘to blame’.

In her keynote address, Nina Pavcnik presented her literature review that assesses the current state of evidence on how international trade shapes inequality and poverty.  Her review focuses mainly on developing countries, reflecting the fact that there is now more evidence in that context, but her discussion drew parallels to the empirical evidence on developed countries as well.  Her review also discusses perceptions about international trade in over 40 countries at different levels of development, including perceptions on trade’s overall benefits for the economy, trade’s effect on the livelihood of workers through wages and jobs, and trade’s contribution to inequality.  In framing the review, she noted that while most studies of developed countries focus on import shocks, studies of developing countries present evidence on export shocks as well to provide a more nuanced picture.

One insight that emerges from Pavcnik’s review is that losers from trade liberalization tend to be geographically concentrated and persistent over time because the costs are large.  Another insight is that worker-firm affiliation matters for how individuals are affected by trade liberalization.  Better performing firms tend to be better equipped to respond to the opportunities arising from trade liberalization.  Declines in industry employment from import competition are concentrated in less productive firms and workers.    A third insight is that one cannot ignore the effects of the informal sector in developing countries.  In some cases, international trade supports economic development by promoting the transfer of labor from inefficient informal firms to more efficient formal firms.  In others, especially where labor markets are poorly functioning or government support for those displaced from employment by trade is absent, the informal sector can serve as a coping mechanism for trade shocks.  Pavcnik noted that these outcomes are in some cases at significant variance to the predictions derived from the classic H-O model, especially because it does not have a role for firms.  The main policy recommendation to come out of her review was that governments must support workers and not jobs, because it is inevitable that the gains from trade are realized through the destruction of jobs, and the costs to workers are substantial.

The program featured two papers that studied the effects of trade policy in India.  The paper presented by Beyza Ural Marchand studies the distributional implications, with a particular focus on the poor, by asking: ‘what would be the distributional effects of eliminating the current protectionist structure?’  Thus her focus is on the welfare implications of a move from current trade policies to free trade.  The welfare effects are estimated through household expenditure and earnings effects of liberalization. The results indicate that Indian trade policy is pro-poor through the earnings channel, as its elimination leads to higher welfare losses for poorer households. But it is pro-rich through the expenditure channel, as its elimination leads to higher welfare gains for poorer households.  On balance, surprisingly, Marchand finds that Indian trade policy is regressive overall.

The paper presented by Ariel Weinberger investigates the liberalization episode in India during the 1990’s, which has been characterized by large and unexpected changes in trade and foreign investment policies.  Contrary to what might have been expected, given the secular decline in labor shares since the 1980s, his paper finds that trade reforms mostly raised the labor-to-capital relative factor shares in India. A reduction in capital tariffs and liberalization of FDI raise the share of income paid to labor relative to capital. His results reveal access to foreign capital as a new mechanism through which openness affects factor shares: imported capital augments technical change and potentially reduces rental rates, both of which raise the relative labor share.  Weinberger and his collaborator attribute the observed overall decline in the labor share to domestic deregulation policies and credit expansion.

Richard Chisik reversed the direction of enquiry relative to the papers above.  Rather than look at the effects of trade on inequality, his paper considers the effect of inequality on trade.  The prior literature notes that a foreign transfer may generate a ‘Dutch disease’ type effect in the recipient country: a transfer brings about a real exchange rate appreciation via an increase in wages that can reduce the size of the manufacturing sector.  This may reduce manufacturing exports or even eliminate a comparative advantage in manufacturing altogether.  In this literature, remittances have been considered isomorphic to foreign aid in causing the Dutch disease. Chisik’s paper questions this apparent similarity.  His paper argues that, whereas aid generates a Dutch disease effect, remittances can lead to growth of manufacturing.  The reason is that (ironically) aid tends to go to wealthier individuals who spend the money on non-traded services, which does appreciate the real exchange rate and shrinks the manufacturing sector, while remittances tend to go to poorer individuals who spend on manufactures which tends to increase the size of that sector.  The differing effects on the relative size of the manufacturing sector have, in turn, different bearings on comparative advantage.  The paper presents econometric results supportive of their model.

Rather than focus directly on trade and inequality, Ben Zissimos looked at how the inequality created by international trade can threaten the survival of dictatorships, especially in the face of world price shocks.  In his paper, the survival of dictatorships is taken to be a bad thing because they tend to support extractive economic institutions that fail to promote economic development.  The theory developed in the paper predicts that, in food exporting dictatorships, a world food price spike can provoke the threat of revolution.  Dictatorships are predicted to respond by making transfers using export taxes, hence defusing the threat of revolution and forestalling democratization.  The prior literature on institutions and development has tended to focus on the use of domestic redistributive taxation for the purposes of defusing the threat of revolution.  But the paper presented by Zissimos draws on evidence to suggest that dictatorships do not install domestic redistributive capacity for fear that it will be used to tax away their wealth.  Trade taxes, which are available to dictators, are used instead for this purpose.  Hence the paper proposes a new motive for the use of trade policy.  It also provides econometric results supportive of the predictions of the model.

Trade and Resource Reallocation Effects of Trade Integration and Institutional Reform

As tariffs have been reduced through multilateral trade rounds and the formation of free trade agreements, attention has shifted to other measures such as product standards, intellectual property protection, and infrastructure in an effort to facilitate integration where appropriate.

The paper presented by Walter Steingress quantifies the heterogeneous trade effects of harmonizing standards on product entry and exit as well as export sales.  Using a novel and comprehensive database on cross-country standard equivalences, the paper identifies standard harmonization events.  To track harmonization events, the paper presents a new correspondence table between the International Classification for Standards (ICS) and Harmonized System (HS) codes.  The results Steingress reported show that, on average, standard harmonization leads to a 0.5% increase in export sales. This effect is driven by an increase in the intensive margin, a decrease in prices and an increase in the quantities sold.  The paper argues that these results are compatible with a theoretical framework where standard harmonization leads to higher fixed costs as companies have to adapt to the new standards, but simultaneously reduced variable costs, thus increasing overall trade flows.

In her paper, Magdalene Silberberger broaches the impact of trade liberalization on health, safety and environmental (HSE) standards.  She and her collaborator ask whether tariff liberalization causes ‘regulatory chill’, meaning that countries are reluctant to implement HSE standards, or instead causes a race to the top as governments seek to use standards as non-tariff barriers to trade.  Her paper analyzes annual country-by-industry data on notifications of changes in sanitary and phytosanitary standards by WTO members. The results suggest that the impact of increased trade pressure depends on whether domestic producers are likely to gain or lose from a change in standards. Regulatory chill is the dominant response in most countries, but countries in which producers can adapt to standards relatively cheaply appear to race to the top.  Consequently, that paper concludes that tariff liberalization is associated with a divergence in standards across countries.

Shifting the focus from standards to patents, Tom Zylkin explored the effects of cross-border patents on international trade.  His paper highlights an ambiguity as to what one might expect here.  On the one hand, a firm might file a patent in another country because it wants to protect a good that it plans to export there.  On the other hand, the reason for filing a patent in another country might be that the firm wants to produce a good there instead of exporting it.  So, he argued, cross-border patents could be complements or substitutes to trade.  Using a highly disaggregated database of all patents filed in and out of developed and developing countries, his paper provides the first systematic analysis of how bilateral trade responds to bilateral filings.  It reports results suggesting large roles for geographic as well as industry-level heterogeneity, suggestive of competing motivations for cross-border patenting.  Patents promote bilateral exports—and negate bilateral imports—in high-demand elasticity industries, but can have the opposite effect in industries where the products are primarily used as intermediate inputs and/or between countries that are not far apart geographically.

The final two papers in this section consider the effects on economic performance of fundamental changes to the domestic economic and political environment.  Mingzhi (Jimmy) Xu‘s paper studies the aggregate and distributional impacts of China’s high-speed railway (HSR) network.  China’s HSR is a passenger rail network that covers 29 of the country’s 33 provincial-level administrative divisions and exceeds 25,000 km/16,000 miles in total length, accounting for about two-thirds of the world’s high-speed rail tracks in commercial service.  Xu argued that HSR connection generates productivity gains by improving firm-to-firm matching efficiency and leading firms to search more efficiently for suppliers.  His paper first provides reduced-form evidence that access to HSR in China significantly promotes exports at the prefecture level.  It then constructs and calibrates a quantitative spatial equilibrium model to perform counterfactuals, taking into account trade, migration, and outsourcing. The quantitative exercise reveals that the construction of HSR between 2007 and 2015 increased China’s overall welfare by 0.46%, but was also associated with an increase in national inequality. In addition, the paper finds that gains from HSR are larger when labor migration costs are higher, implying that the HSR project is well suited to a country like China, which features high internal migration barriers.

Ama Baafra Abeberese’s paper considers the implications of democratic reform for firm productivity, and in particular the impact of President Suharto’s unexpected resignation from the Presidency of Indonesia in 1998, after more than three decades in the post.  The basic idea underpinning the paper is that politicians can create high entry barriers for firms in order to collect rents from those that do enter.  Arguably, since this concentrates the gains from economic activity, democratically elected politicians will be less able to create such barriers without being displaced from office, and so the environment under democracy should be more competitive.  However, the effect on firm productivity is ambiguous since a more competitive environment may make it more difficult for firms to become established.  Baafra’s paper uses the fact that, in Indonesia, local mayors’ terms were asynchronous.  This asynchronicity of terms means that the paper can identify variation in the productivity of firms operating under mayors appointed by Pres. Suharto versus mayors who were democratically elected after Suharto stepped down.  The main result Baafra presented was that democratization did in fact boost productivity, and more so in industries that were shown to be politically connected to the Suharto regime and hence presumably more sheltered when he was in office.

Institutional Constraints on Trade Policy

While it might be collectively rational for countries to adopt free trade, it is often individually rational for a government to adopt some degree of trade protection.  This observation has been used to provide motivation for why governments sign up to institutional measures that constrain their abilities to set trade policy unilaterally, often in the form of a trade agreement.  This way of thinking forms the basis for the literatures on the purpose of the General Agreement on Tariffs and Trade (GATT), now absorbed into the Articles of the World Trade Organization (WTO), as well as the purpose of preferential trade agreements.

David DeRemer opened the discussion of these issues at the workshop with a paper that provides a new framework for thinking about international trade agreements in modern trade environments such as those involving offshoring, and rent seeking by foreign governments.  These are environments that extend beyond those which standard models of trade agreements are set up to consider.  His presentation started out by taking a stance on what distinguishes modern trade negotiation environments from the earlier era.  The new framework he developed focuses on how trade agreements help countries to escape from prisoner’s dilemmas in which each government disregards the effects of local price, as opposed to world price, changes on trading partners.  He argued that, typically, these local prices matter because they affect foreigners’ producer surplus or value-added.

His paper considers trade agreements that achieve the stable end-point of reciprocal negotiations, meaning a situation where neither government can gain from policy changes that affect net export value equally.  The paper shows this end point is Pareto efficient for governments, so it is a suitable prediction for the trade negotiation outcome.  This stable and efficient outcome for modern trade environments yields new predictions that are consistent with empirical evidence.  For example, more politically organized exporters with large supply elasticities compel governments to undertake greater reductions in cooperative import tariffs from trade negotiations.  In this setting, governments jointly pursue gains for exporters to the extent that they would assess losses for domestic firms from import competition to be outweighing gains for consumers.

Woan Foong Wong’s paper focused specifically on the main WTO rules that govern free trade agreement (FTA) formation.  Her paper is based on a three country ‘competing exporters model’, where any two countries compete to export a given product to the third country.  An FTA can then be formed between two countries, leaving the third one out, or all three countries can adopt global free trade, with the outcome being endogenously determined.  FTA formation under Article 24 of the GATT/WTO requires that external tariffs not be raised, and all internal tariffs be removed.  Wong’s paper examines the implications of the requirement to remove internal tariffs by comparing the outcome when this requirement is adhered to with when it is relaxed.  She showed that requiring FTAs to eliminate internal tariffs makes the non-member better off although it simultaneously reduces the likelihood of achieving global free trade by encouraging free-riding on its part.  The reason is that setting lower internal tariffs creates an incentive for members to set lower external tariffs, since they compete more aggressively for the third market, which benefits the non-member.  This problem is avoided by customs union members who, unlike FTA members, coordinate their external tariff.  Therefore, surprisingly, in the case of FTA formation removing the ‘free internal trade requirement’ increases the parameter space where global free trade is a stable outcome.

Other papers at the workshop undertook econometric work to explore the implications of trade agreement formation.  The paper presented by Kishore Gawande undertook the first econometric test of the commitment-based theory of trade agreements.  The idea of this theory is that import-competing sectors where industry interest groups know they can lobby the government for protection will end up with tariffs set above efficient levels and over-investment in capital.  But if governments realize that they cannot receive sufficient compensation for such long-run distortions, they may choose to sign a trade agreement and thus tie their hands to efficient trade policy, thereby shutting down lobbying altogether.  Gawande’s presentation reported econometric results testing this theory against industry-level and firm-level data, and found supportive evidence for the model in the data.

Yifan Zhang‘s paper investigates the impacts of trade liberalization on household behavior and other outcomes in urban China resulting from that country’s entry to the WTO in 2001.  The identification strategy employed in the paper exploits regional variation in the exposure to the resulting tariff cuts.  The paper finds that workers in regions initially specialized in industries facing larger tariff cuts experienced relative declines in wages. Households responded to these income shocks in several ways. First, household members were found to work more, especially if they moved into the non-tradable sector. Second, young adults were more likely to live longer in the parental household, and so average household size increased. Third, households tended to save less. These changes in bahavior were interpreted as being motivated by attempts by households to buffer themselves against the negative wage shocks induced by trade liberalization.

There is a long-held view in the trade policy literature that traditional tariff instruments and temporary protection (TP) measures such as anti-dumping and countervailing duties are substitutes. However, David J. Kuenzel argued in his presentation that there is only mixed empirical evidence for a link between tariff reductions and the usage pattern of antidumping, safeguard and countervailing duties. Based on recent theoretical advances, his paper argues that the relevant trade policy margin for implementing TP measures is instead the difference between WTO bound and applied tariffs, or ‘tariff overhang’ as it is often known. Lower tariff overhangs constrain countries’ abilities to raise their MFN applied rates without legal repercussions, independent of past tariff changes. Using detailed sectoral data for a sample of 30 WTO member countries during the period 1996-2014, Kuenzel finds strong evidence for an inverse link between tariff overhangs and TP activity. This result implies that tariff overhangs and TP measures are substitutes.  Based on this finding, he argues that this indicates the importance of existing tariff commitments as a key determinant of alternative TP instruments.

Bibliography of Papers Presented with Links Where Available (Presenters’ Names Shown in Bold)

Abeberese, A.B., P. Barnwal, R. Chaurey, and P. Mukherjee “Firms Under Dictatorship and Democracy: Evidence from Indonesia’s Democratic Transition.”

Aisbett, E., and M. Silberberger “Tariff Liberalisation and Protective Product Standards.”

Antràs, P., T.C. Fort and F. Tintelnot, “The Margins of Global Courcing: Theory and Evidence from US Firms.

Antràs, P., and A. de Gortari, “On the Geography of Global Value Chains.

Abeberese, A.B., P. Barnwal, R. Chaurey, and P. Mukherjee, “Firms under Dictatorship and Democracy: Evidence from Indonesia’s Democratic Transition.”

Baccini, L., H. Cheng, K. Gawande, and H. Jo, “The Political Economy of Trade Agreements: A Test of a Theory.”

Behzadan, N., and R. ChisikThe Paradox of Transfers: Distribution and the Dutch

Brunel, C., and T. ZylkinDo Cross-Border Patents Promote Trade?

Dai, M., W. Huang, and Y. Zhang,How Do Households Adjust to Trade Liberalization? Evidence from China’s WTO Accession.

DeRemer, D.R., “The Principle of Reciprocity in the 21st Century: New Predictions for Trade Agreement Outcomes.

Gawande, K., and B. Zissimos,How Dictators Forestall Democratization Using International Trade Policy.”

Herkenhoff, P., and S. Krautheim, The International Organization of Production in the Regulatory Void.

Kuenzel, D.J., WTO Tariff Commitments and Temporary Protection: Complements or Substitutes?

Leblebicioglu, A., and A. Weinberger, “Openness and Factor Shares: Is Globalization Always Bad for Labor?”

Machiavello, R., and M. Florensa, “Improving Export Quality and What Else? Nespresso in Colombia.”

Marchand, B.U.,Inequality and Trade Policy: Pro-Poor Bias of India’s Contemporary Trade Restrictions.”

Pavcnik, N., “The Impact of Trade on Inequality in Developing Countries.”

Saggi, K., W.F. Wong, and H.M. Yildiz, “Preferential Trade Agreements and Rules of the Multilateral Trading System.”

Schmidt, J., and W. Steingress, “No Double Standards: Quantifying the Impact of the Standard Harmonization on Trade.”

Xu, M., “Riding on the New Silk Road: Quantifying the Welfare Gain from High-Speed Railways.”

Foreign Investment Boosts Sophistication of Domestic Manufacturing: New Evidence from Turkey

By Beata Javorcik (University of Oxford), Alessia Lo Turco, (Marche Polytechnic University), Daniela Maggioni (University of Catania)

Recently, there has been a renewal of interest in industrial policy across the world. Advanced economies promise to use industrial policy to revive their declining manufacturing, while emerging markets hope that industrial policies will help them upgrade their production structure and in this way stimulate economic growth. Yet, little is known about the micro determinants of product upgrading.

The existing research suggests that inflows of foreign direct investment (FDI) can foster host countries’ production upgrading, where upgrading is measured in terms of the unit values of exports (Harding and Javorcik,  2012).[1]

In our recent work, we move away from unit values – a highly imperfect proxy for product quality –  and examine the link between FDI and product upgrading, as captured by complexity of new products introduced by domestic firms.[2] We focus on manufacturing firms in Turkey, a country that has experienced a spectacular surge in FDI inflows during the 2000s and dramatically increased the sophistication of its productive structure in the last decades.[3]

Anecdotal evidence

Anecdotal evidence suggests that foreign affiliates stimulate product upgrading among their suppliers. For example, Indesit Company, an Italian white good producer – recently acquired by Whirlpool – has produced refrigerators in Turkey since the 1990s. In 2012, Indesit built a new plant to produce washing machines. To become a supplier of this new plant, a local company purchased new presses and automated its production process. This allowed it to start producing a new and more sophisticated product, a washing machine flange, and to increase efficiency and production volumes. The flange is a very complex product as it needs to be produced with no aesthetic defects by an 800-1,000 tonne metal presses. It also needs to withstand the stress of between 1,000 and 1,400 revolutions per minute while remaining within a certain range of vibration and noisiness. Indesit has shared essential tacit knowledge, information processes, instructions and control procedures with the local company, thus stimulating and supporting the supplier’s complexity upgrading.

Inspired by the anecdotal evidence, our study examines the link between the presence of foreign affiliates and production upgrading by Turkish firms located in the same region and active in the input-supplying industries.

Measuring product complexity

To capture product complexity we use a measure proposed by César Hidalgo and Ricardo Hausmann, who relate the concept of product complexity to the extent and exclusivity of capabilities needed to produce a given product.[4] It is easiest to explain this measure using a Lego analogy. Think of a country as a bucket of Lego pieces with each piece representing the capabilities available there. The set of products (i.e., Lego models) a country can produce depends on the diversity and exclusiveness of the Lego pieces in the bucket. A Lego bucket that contains pieces that can only be used to build a toy bicycle probably does not contain the pieces to create a toy car. However, a Lego bucket that contains pieces that can build a toy car may also have the necessary pieces needed to build a toy bicycle.  While two Lego buckets may be capable of building the same number of models, these may be completely different sets of models. Thus, determining the complexity of an economy by looking at the products it produces amounts to determining the diversity and exclusivity of the pieces in a Lego bucket by simply looking at the Lego models it can build.

Our findings

Our analysis suggests that the presence of foreign affiliates does not affect the propensity of Turkish firms to innovate. However, the presence of foreign affiliates is positively correlated with the complexity level of products newly introduced by Turkish firms active in the supplying industries and located in the same region.

The estimated effect is economically meaningful. A 10 percentage point increase in foreign presence implies moving about half of the way from the production of pot scourers to producing stainless sinks. An increase of about 17 percentage points in FDI in the relevant sectors would be necessary in order to move from the production of stainless sinks to the production of the washing machine flanges.


Our findings matter for policy. Dani Rodrik argues that enhancing an economy’s productive capabilities over an increasing range of manufactured goods can be considered an integral part of economic development.[5] As foreign affiliates facilitate the upgrading of the host country’s productive capabilities, our results, then, imply that FDI inflows can act as an important stimulus for economic growth. Thus, there is room for investment promotion activities, a policy that is quite effective in developing countries.[6] In contrast to many other industrial policies, investment promotion is relatively inexpensive and causes few distortions. Therefore, there is little downside when the government gets it wrong.


Harding, T. and Javorcik, B.S. (2011). ‘Roll out the red carpet and they will come: investment promotion and FDI inflows’, Economic Journal, vol. 121(557), pp. 1445–1476.

Harding, T. and Javorcik, B.S. (2012). ‘Foreign direct investment and export upgrading’, The Review of Economics and Statistics, vol. 94(4), pp. 964–980.

Hidalgo, C.A. and Hausmann, R.(2009). ‘The building blocks of economic complexity’, Proc. Natl. Acad. Sci., vol. 106, pp. 10570–10575.

Javorcik, B.S., Lo Turco, A., Maggioni, D. ‘New and Improved: Does FDI Boost Production Complexity in Host Countries?‘ Economic Journal, forthcoming.

Rodrik, D. (2006). ‘Industrial development: stylized facts and policies’, Kennedy School of Government.


[1] See Harding and Javorcik (2012).

[2] Javorcik, Lo Turco and Maggioni (forthcoming).

[3] See Hidalgo (2009).

[4] See Hidalgo and Hausmann (2009)

[5] See Rodrik (2006)

[6] Harding and Javorcik (2011)

Global Inequality, Investment, and Trade Frictions in Capital Goods

Since 1950 the global Gini coefficient for between-country income inequality has stood at about 55, reflecting a twenty five-fold difference in wealth between the richest and poorest countries. A well-known stylized fact underpinning this feature of the world economy is that the real investment rate of wealthy countries such as Norway and the United States is roughly two to three times that of poor countries such as Mali and Kenya.  Based on this evidence, the literature seeking to understand international inequality has attributed a key role to differences in physical capital intensity.

The early literature attributes low capital intensity to low savings rates, combined with limited international capital mobility.  Low savings rates have been attributed in turn to poor institutions, and policies that result in high effective tax rates on capital income such as high explicit tax rates, high discount rates, and high dependency ratios.  Alternatively, low-saving traps have been attributed to subsistence consumption needs.  This line of reasoning formed the intellectual foundations for the lending work of institutions such as the World Bank.

A more recent strand of the literature assigns a central role to factors that directly determine the cost of capital.  From this perspective, poor countries have low real investment rates because they tax capital goods, erect or endure barriers to trade in capital goods, or grant monopoly rights to domestic capital goods producers.  Recent contributions to this literature have been organized around an Eaton Kortum (EK) model wherein capital can grow both through domestic and imported capital formation.  Within this framework, trade frictions have been identified as quantitatively important in understanding why standards of living and measured total factor productivity between the richest and poorest countries differ by so much.

Carroll, C.D., B.-K. Rhee, and C. Rhee (1994); “Are here Cultural Effects on Saving? Some Cross-Sectional Evidence.Quarterly Journal of Economics, 109(3): 685–99.

Caselli, F., and J. Feyrer, (2007); “The Marginal Product of Capital.Quarterly Journal of Economics 122 (2): 535–568. [Working paper version]

Easterly, W., and S. Rebelo. 1993. “Fiscal Policy and Economic Growth: An Empirical Investigation.” Journal of Monetary Economics, 32(3): 417–58.

Eaton, J., and S. Kortum, (2001); “Trade in Capital Goods.European Economic Review 45:1195–1235. [Working paper version]

Higgins, M., and J.G. Williamson, (1997); “Age Structure Dynamics in Asia and Dependence on Foreign Capital.Population and Development Review, 23(2): 261–93.

Hsieh, C.-T., (2001); “Trade Policy and Economic Growth: A Skeptic’s Guide to the Cross-National Evidence: Comment.” In NBER Macroeconomics Annual 2000, Volume 15, NBER Chapters. National Bureau of Economic Research, Inc, 325–330.

Hsieh, C.-T. and P.J. Klenow, (2007); “Relative Prices and Relative Prosperity.American Economic Review 97 (3):562–585. [Working paper version]

Rodriguez, Francisco and Dani Rodrik. 2001. “Trade Policy and Economic Growth: A Skeptic’s Guide to the Cross-National Evidence.” In NBER Macroeconomics Annual 2000, Volume 15, NBER Chapters. National Bureau of Economic Research, Inc, 261–325.

Waugh, M.E., (2010); “International Trade and Income Differences.American Economic Review 100 (5):2093–2124.

Solutions to the Lucas Paradox

The Lucas Paradox draws attention to the fact that capital should flow from rich to poor countries, but that on average the flow is in the other direction.  Lucas’ original (1990) illustration of this phenomenon was couched in terms of a neoclassical model in which two identical countries produce identical goods from a common constant returns to scale production technology.  With all else equal, differences in income per capita reflect differences in capital per capita.  Incomes are lower in the country where capital is more scarce, and returns to capital there are higher to reflect this scarcity.  If capital is allowed to flow freely between the two countries, then the higher returns in the poorer country should bring about a net capital inflow.  So why do we not tend to observe this in the data?  The theoretical literature has identified two main reasons.  The first is due to differences in features of the economy that affect production, including differences in technology, differences in the availability of human capital, differences in the stability of government and differences in the quality of underlying institutions.  The second is due to differences in the functioning of capital markets; even though the expected returns to capital in a given country may be high, a high level of uncertainty associated with the returns may dissuade capital from flowing there.  Recent empirical work has begun to substantiate these theoretical explanations.

Alfaro, L., S. Kalemli-Ozcan, and V. Volosovych, (2008); “Why Doesn’t Capital Flow from Rich to Poor Countries? An Empirical Investigation.” Review of Economics and Statistics 90(2): 347–368. [Working paper version]

Gertler, M., and K. Rogoff, (1990); “North-South Lending and Endogeneous Domestic Capital Market Inefficiencies,” Journal of Monetary Economics 26: 245–266.

Gordon, Roger H., and A. Lans Bovenberg, “Why Is Capital so Immobile Internationally? Possible Explanations and Implications for Capital Income Taxation?” American Economic Review 86: 1057–1075. [Working paper version]

King, R., and S. Rebelo, (1993); “Transitional Dynamics and Economic Growth in the Neoclassical Model.American Economic Review, 83 (1993), 908–931. [Working paper version]

Lucas, Robert E., (1990); “Why Doesn’t Capital Flow from Rich to Poor Countries?” American Economic Review 80: 92–96.

Tornell, A., and A. Velasco, (1992); “Why Does Capital Flow from Poor to Rich Countries? The Tragedy of the Commons and Economic Growth.Journal of Political Economy 100: 1208–1231. [Working paper version]