Category Archives: Institutions

Immigration, Voting and Redistribution: Evidence from European Elections

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By Simone Moriconi (IESEG School of Management and LEM), Giovanni Peri (University of California Davis), and Riccardo Turati (Université Catholique de Louvain)

The idea that political support for redistribution and public good provision is lower in societies with high exposure to immigration and diversity is widely acknowledged. In the US, the great migration inflows of the early 20th century, despite having positive economic effects, reduced public support for the provision of public goods.[1] Similarly in Europe, the inflow of low skilled immigrants during the 2000s weakened citizens’ preferences for redistribution.[2] Natives generally perceive immigrants as a burden to their country’s welfare system, especially if their income is lower, and if they choose their location based on the generosity of the local welfare state (the so-called ‘welfare magnet theory’).  Recent experimental evidence confirms these findings and demonstrates that immigrants’ characteristics are important in affecting the link between immigration and natives’ attitudes towards the welfare state.[3] For instance, high-skilled immigrants, who are most often perceived as net contributors to the welfare state, do not generate anti-welfare attitudes in natives.

Given this evidence, it is important to see how the effect of immigration on preferences translates into policies. A straightforward way is to look at the effect of immigration on voting outcomes. This is the objective of our recent paper, which discusses how migration affected voters’ political preferences over welfare state and public education expansion over 28 elections in 12 European countries between 2007 and 2016.[4] For this analysis, we have primarily used data from the European Social Survey (ESS). These extremely detailed individual data include the name of the party voted for by survey respondents at the last national election. Thus, we selected countries characterized by at least 2 elections during the sample period and linked to each party a synthetic measure, drawn from the party’s political manifesto, of that party’s support for an expansion of the welfare state or for public education. Finally, we merged these data with the stock of immigrants, classified by their education level, who were resident in the region of the survey respondent in the year of the election.

Using these data, we show that voting outcomes are significantly related to the local exposure to immigration, with different effects of low skilled and high skilled immigrants. An increase of high skilled immigration to the region makes individual voters more prone to vote in favour of parties with a political manifesto favourable to welfare and public education expansions. This remains true after accounting for confounding factors, most importantly omitted variable bias driven by the fact that migrants may choose to go to richer regions, and where natives are more pro-redistribution. Our dataset also allows us to show that the effect of high skilled migration on voting outcomes varies with voters’ characteristics. Figure 1 shows the effect is generally larger among the less educated, male voters, residing in small rural areas and it is concentrated either in the younger cohort of natives (below 38 y.o) or the older ones (above 58 y.o.). Educated, female, prime-age and urban voters don’t seem to respond with the same intensity.

Figure 1 : New Welfare State Expansion and Natives’ Individual Characteristics

Source: Moriconi, Peri, and Turati (2019). The graphs plot the coefficients for the effects of the share of high skilled and low skilled immigrants on the indicator of preference for a net welfare expansion. Coefficients are estimated on different subsamples by individual characteristics of natives: education (a), age (b), gender (c) and location (d). All the coefficients are estimated with IV estimations. The shadowed area represents the 95% interval of confidence. All the regressions include individual and regional controls, NUTS2 and year fixed effects. These are the authors’ calculations on ESS, Manifesto Project Database and Eurostat data.

What about the effects of low skilled migration? As for the welfare state dimension of redistribution, low skilled migration does not seem to have much effect on the voting behaviour of natives (see Figure 1). However, we find that natives respond to low skilled immigration by voting for parties that propose to reduce public education: natives may prefer to reduce spending on local public goods fearing that these will benefit primarily less-skilled (and low-income) immigrants.[5] And public education could be benefitting especially newly arrived migrants, who are younger and have more children.

Are the estimated effects sizeable ones? Our estimated coefficients suggest that an increase in the stock of high skilled immigrants by 3 percentage points implies a shift of voters from a moderate Centrist-agenda on education provision and redistribution to the more progressive type of political platforms that characterize most Socialist parties in Europe. An effect quantitatively similar, but with an opposite sign (i.e. a switch towards parties less-favourable to redistribution) is induced instead by an increase in the share of less-educated immigrants by 6 percentage points.

We also perform a complementary exercise to check whether country-level immigration induces parties themselves to change their political agenda. We find that an inflow of low skilled migrants induces parties in a country to propose a political manifesto less favourable to welfare state expansion. This suggests that not only voters, but also parties are to be considered “political agents”, as they adjust their attitudes towards redistribution. As shown in Figure 2 below, this is not only the case for conservative types of parties, but also for some “pro-redistribution” parties such as the Christian Democrats. Our findings suggest that in response to low skilled immigration, European countries’ party systems may have evolved over time to support smaller government size, and this would amount to a change in policy preferences revealed by parties even if voters did not much change their vote across parties.

Figure 2: Parties Families – Average position and Variation
Source: Moriconi, Peri and Turati (2018). The top panel plots the average position of political families, using the initial and the average political position of parties. Initial position is measured by the manifesto in the last available election before the start of the sample period, or the first year when the party is present in the political arena during the sample period (2007-2016). Average political position is measured as the average political manifesto of a party during the sample period 2007-2016. Number of parties in each family are reported over the bars. The bottom panel plots the variation of political families average position regarding welfare state expansion keeping a balanced sample of parties.

References

Alesina, A., A. Miano & S. Stantcheva (2018). “Immigration and Redistribution.” NBER Working paper 24733.

Card, D., C. Dustmann & I. Preston (2012). “Immigration, Wages and Compositional Amenities.” Journal of the European Economic Association 10(1): 78–119.

Moriconi S., Peri G. and R. Turati (2019). “Immigration and Voting for Redistribution: Evidence from European Elections.” Labour Economics 61 (2019) 101765.

Murard, E. (2017). “Less Welfare or Fewer Foreigners? Immigrant Inflows and Public Opinion towards Redistribution and Migration Policy.” IZA DP No. 10805.

Tabellini, M. (2020). “Gifts of the Immigrants, Woes of the Natives: Lessons from the Age of Mass Migration.” Review of Economic Studies 87(1): 454–486,

Endnotes

[1] See Tabellini (2020)

[2] See e.g. Murard (2017)

[3] Alesina et al. (2018)

[4] Moriconi et al. (2019)

[5] Card et al. (2012)

Economic Determinants of Multilateral Environmental Agreements

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By Tibor Besedeš (Georgia Institute of Technology), Erik P. Johnson (Carthage College), and Xinping Tian (Hunan University)

Multilateral environmental agreements come in many flavors. Between 1950 and 2012 over 1100 such agreements have been negotiated between countries. These agreements cover a variety of issues including newer concerns such as global warming and climate change as well as older ones such as acid rain, degradation of habitats, and overfishing. The large number of agreements points to a telling difference between environmental agreements and another type of agreement countries often negotiate, namely the one dealing with international trade. A pair of countries tends to negotiate a single trade agreement that is either comprehensive and covers the entirety of trade between the two (such as NAFTA) or excludes some goods from coverage (many agreements Japan negotiates do not cover agriculture). In the environmental arena, agreements tend to be more issue-specific resulting in the same pair of countries signing many more agreements. For example, prior to 1990 France had ratified 213 multilateral agreements. Among these 179 are between France and Germany, its EU partner, with the agreement underpinning the EU being the sole agreement covering international trade between the two. France and Mexico are both parties to 69 agreements, while prior to Slovakia’s entry into the EU, France had no environmental agreements with Slovakia despite their close proximity to each other. The reasons for the different number of agreements are varied. Some have to do with proximity. France and Germany are neighboring countries and have entered into agreements to deal with transboundary environmental issues such as management of resources spanning the common border or pollution that straddles the border. Given Mexico and France are separated by the Atlantic Ocean, there are significantly fewer environmental issues the two have in common and hence fewer agreements that both are parties to.

The distance between France and Germany on one hand and France and Mexico on the other plays an important role in determining what kinds of environmental agreements they enter. The common border shared by France and Germany generates transboundary issues that need to be managed, be they resource management or habitat preservation. Mexico and France have no such issues. Rather, Mexico and France are much more likely to be signatories of large multilateral agreements that many or all countries in the world sign on to, such as the Montreal Protocol (negotiated to phase out production of substances that deplete the ozone) or the Kyoto Protocol (negotiated to reduce greenhouse gases). France and Germany are also party to such agreements, but also are parties to more agreements that are small in nature, in terms of the number of signatories. These small agreements are between fewer countries as they are designed to deal with specific issues affecting a small set of countries near each other that share common pool resources that need to be managed.

The number of signatories to an agreement is also an important variable, as it may determine how effective and stable agreements are. Several theoretical papers have shown that self-enforcing environmental agreements between many countries will arise when the difference in net benefits between the non-cooperative and fully cooperative outcomes is very small.[1] In other words, large agreements will be formed only when commitments that countries must agree to are small or non-existent. On the flip side, small agreements, between few signatories can be much more effective at dealing with a variety of environmental issues.[2] In other words, large agreements may be an expression of a desire to do something about an issue at some point but entail no immediate commitment to act. Small agreements are more likely to contain binding commitments. Large agreements may be examples of what Scott Barrett characterizes as consensus agreements, which are “broad but shallow”, rather than “narrow but deep,” which tends to be a more apt description of small agreements.[3]

The main thrust of our recently published paper in this area is to understand the economic determinants of environmental agreements.[4] A common concern attributed to many environmental agreements is that they will usually result in additional regulation and new limits on economic activity resulting in economic losses. As such, it is important to understand the extent to which economic factors play a role in countries agreeing to sign an environmental agreement. Given the above discussion, we hypothesize that economic determinants play an important role in determining two countries becoming parties to a small agreement with few other countries. However, when it comes to large, globe-spanning agreements, we hypothesize that economic factors play no role in determining whether two countries sign it.

We use data on multilateral environmental agreements from Ronal Mitchell’s International Environmental Agreement Database Project (2002-2015) on agreements signed between 1950 and 2012.[5] We use these data to examine two aspects: the likelihood that a pair of countries signs a (new) environmental agreement and the number of agreements the pair is currently a party to. We use three groups of explanatory variables. The first are variables used in the international trade gravity literature: sum of GDPs, difference in GDPs, distance, and common language. The second are economic integration variables: sum of imports and existence of a trade agreement between the two countries. The last group of variables are proxies for common pool resources: the length of border between the two countries, whether they are in the same geographic region, or whether they are in neighboring regions. We separately analyze agreement with less than 26 signatories, the median number of signatories of all agreements in our sample, and agreements with more than 68 signatories, which is the 75th percentile in the distribution of the number of signatories across all agreements.

The first step in our analysis is to show that proxies for common pool resources are good proxies. We do so by collecting data on two types of common pool resources we could find that span across countries, namely aquifers and transboundary waters. In both cases, countries that have a longer border, and/or are in the same or neighboring regions, are more likely to either share aquifers or transboundary waters.

In the second step we examine the determinants of the likelihood that countries enter into an environmental agreement. A pair of countries with larger joint GDP but with smaller differences between them (i.e., countries more similar in economic size), that trade more, that are closer in distance, that have a longer border, that share a common language, that are in the same or neighboring regions, and that have a trade agreement are more likely to sign an environmental agreement that has a small number of signatories in virtually any year of our sample. These same factors also cause a pair of countries to be parties to more agreements, except for common language and being in neighboring regions which do not have significant effects. When it comes to large agreements, these same factors either do not have significant effects, or their effect decreases over time.

The conclusion we reach based on our results is that economic factors play a role in determining whether a pair of countries signs a small agreement. In these cases, economic factors matter as small agreements have bite: they usually come with binding commitments that often manifest themselves in costs. On the other hand, when it comes to agreements with many signatories, economic factors play a minor role at best because such agreements entail no costs making it easier for countries to join. The lack of costs associated with the agreement implies that there are few economic considerations countries have to worry about when joining such agreements.

References

Asheim, Geir B., Camilla Bretteville Froyn, Jon Hovi, and Frederic C. Menz (2006), “Regional versus Global Cooperation for Climate Control,” Journal of Environmental Economics and Management, 51 93-109.

Barrett, Scott (1994), “Self-Enforcing International Environmental Agreements,” Oxford Economic Papers 46, 878–894.

Barrett, Scott (2002), “Consensus Treaties.” Journal of Institutional and Theoretical Economics 158 (4), 529-547.

Besedeš, Tibor, Erik P. Johnson, and Xinping Tian (forthcoming), “Economic Determinants of Multilateral Environmental Agreements.” International Tax and Public Finance, doi: 10.1007/s10797-019-09588-z

Gelves, Alejandro, and Matthew McGinty (2016), “International Environmental Agreements with Consistent Conjectures.” Journal of Environmental Economics and Management 78, 67-84.

Hovi, Jon, Hugh Ward, and Frank Grundig (2015), “Hope or Despair? Formal Models of Climate Cooperation.” Environmental and Resource Economics 62(4), 665-688.

Endnotes

[1] See Barrett (1994) and the references therein.

[2]  See Asheim et al. (2006), Gelves and McGinty (2016), and Hovi et. al. (2015).

[3] See Barrett (2002).

[4] Besedeš, Johnson and Tian (forthcoming).

[5] http://iea.uoregon.edu/

Optimal Trade Policy with Trade Imbalances

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By Mostafa Beshkar (Indiana University at Bloomington) and Ali Shourideh (Carnegie Mellon University)

A salient feature of international trade is the presence of trade imbalances. How should governments conduct their trade policy under trade imbalances? In a forthcoming paper we ask if trade imbalances influence governments’ choices of trade policies under a standard dynamic trade model.[1] This analysis could shed light on the policy debates in recent years where a widening trade deficit has prompted calls for protectionist policies in the United States and other countries with major levels of trade deficit.

Method

We use a dynamic economic model to study the potential impact of fluctuations in trade volumes and trade deficits on the unilaterally-optimal choice of trade and capital control policies—namely, policies that maximize a measure of welfare of the home country disregarding their effects on the rest of the world.

By using a dynamic framework in which international lending and borrowing—and hence trade imbalances—may occur endogenously, our analysis departs from most of the trade policy literature that focuses on static models with the assumption of balanced trade or an exogenously-given trade deficit.

Using a dynamic—as opposed to static—framework has several advantages for policy analysis. First, it allows researchers to study the relationship between economic fluctuations and trade policy. The vast literature on trade policy—which has concerned itself mostly with static impacts of trade policy—cannot properly address this relationship.

A second advantage of a dynamic framework for trade policy analysis is the ability that it affords researchers to study the potential interdependence between trade and capital control policies. This potential policy interdependence may have important implications for the design and benefits of trade agreements. For example, while trade agreements such as the WTO restrict trade policies, they leave exchange and capital controls to the discretion of the member governments. Therefore, following negotiated trade liberalizations, governments may have an incentive to use exchange and capital controls more actively to affect trade flows to their advantage. It is notable that shortly after its accession to the World Trade Organization, China was frequently accused of manipulating its exchange rate to affect the flow of goods and services.

The use of a dynamic framework is also advantageous for quantitative analysis of trade policy as it could match observed trade flows that involve substantial trade imbalances. The balanced-trade assumption in the previous literature poses a problem for quantitative analysis as it violates the observed trade data. The static trade literature has so far dealt with this problem in one of two ways. The first approach is to introduce aggregate trade imbalances as constant nominal transfers into the budget constraints. The second approach is to “purge” the data from imbalances, namely, conducting the analysis under the counterfactual in which trade is balanced.[2]  A dynamic approach, however, provides a more satisfactory solution by allowing trade imbalances to occur endogenously

Results

A key determinant of optimal trade and capital control policy in a given period is the productivity of the home country relative to the rest of the world in that period. The time variation in these policies, however, depend critically on the set of policy instruments that are employed by the government.

An important case is one in which trade taxes are the only policy instruments at the government’s disposal—i.e., there are no capital control taxes. Under this scenario, there is significant variation in optimal trade policy over time.  In particular, in the absence of capital control taxes, the optimal level of import restriction and export promotion—namely, import taxes and export subsidies—is counter-cyclical.

The counter-cyclicality of import tariffs and export subsidies reflects the government’s desire to improve the country’s intertemporal terms of trade.  That is, individual households ignore their collective effect on the world interest rate and, thus, save and lend too much in booms and borrow too much in downturns, which negatively affects the interest rate for domestic households. To correct for this “inefficiency,” the government’s optimal policy response would be to decrease the price of consumption in high-productivity periods relative to low-productivity periods. This objective may be achieved by applying lower import tariffs together with higher export subsidies in low-productivity periods.

Figure 1 Panel A

Figure 1 Panel B

Figure 1 depicts the optimal level of import and export taxes that we calculate in our paper, for the United States for each year from 1995 to 2016. As can be seen in this figure, over this time period optimal tariffs vary between 27% and 33%, and export subsidies vary between zero and 6%. Nevertheless, if capital controls are used in lieu of export subsidies, the time-variation of import tariffs is virtually eliminated—with tariffs hovering around 25% for the entire period.

The gradual increase in trade protection in the first-half of the time period in Figure 1 reflects an optimizing government’s motivation to discourage borrowing by households from the rest of the world during this relatively fast growth period. Conversely, the gradual decline in the optimal level of protection after 2003 reflects the government’s desire to encourage domestic consumption in lieu of lending to the rest of the world.

Despite the significant time-variation in import taxes and export subsidies that is depicted in Figure 1, the total level of trade protection, measured by the product of import and export taxes, namely, (1+import tax)*(1+export tax), remains relatively constant (around 25%) for the entire time period. In other words, the desired relative price of domestic and imported goods may be implemented using a 25% import tariff alone. Nevertheless, to induce the desired interest rate—or, equivalently, the desired relative price of aggregate consumption across periods—both tax instruments are necessary. This observation suggests that the famous Lerner Symmetry Theorem should be interpreted cautiously in practice.

Remaining Questions

Given the insights we have discussed above, an interesting question that could be addressed in future research is whether capital controls could serve a useful purpose as a flexibility mechanism in trade agreements. Flexibility may be a desirable feature for trade agreements for at least two reasons. First, if political economy preferences are subject to shocks in the future governments will negotiate an agreement that includes a mechanism for policy flexibility such as the WTO Agreement on Safeguards.[3] Second, if trade agreements must be self-enforcing, flexibility in capital control policies could reduce the governments’ incentive to renege on the agreement at times when a surge in imports or a widening trade deficit increases temptations to leave an international agreement.[4]

The possibility of time variation in trade policy is also important in understanding the potential relationship between the state of the economy and optimal trade policy. This is particularly so in order to understand the pattern of optimal trade taxes over the business cycle and the potential relationship between the growth rate of the economy and the optimal conduct of trade policy.  Our model offers a tractable framework in which to explore these issues.

Conclusion

In conclusion, it is worth noting that although the magnitude of changes in optimal tariffs are significant, the quantitative analysis suggests that the gains from this variation are small. In particular, a constant tariff can achieve almost all of the gains from implementing the optimal policy. This finding also implies that under our framework, the negative externality of optimal capital control taxes on the rest of the world is very small.

These quantitative results, however, should be taken with a grain of salt as they hinge on various simplifying assumptions, including the assumption that labor is the only factor of production and no investment in physical capital takes place. Enriching the model by allowing for the possibility of physical capital formation could potentially magnify the welfare effects of capital control policies.

References

Bagwell, K., and R. Staiger, (1990); “A Theory of Managed Trade.” American Economic Review, 80(4): 779-795.

Maggi, G., and R. Staiger (2011); “The Role of Dispute Settlement Procedures in International Trade Agreements.” The Quarterly Journal of Economics, 126, (1): 475-515.

Beshkar, M., and E. Bond, (2017); “Cap and Escape in Trade Agreements.” American Economic Journal – Microeconomics. 9(4): 171–202.

Beshkar, M., and A. Shourideh, (2020); “Optimal Trade Policy with Trade Imbalances.” Journal of Monetary Economics.

Ossa, R. (2016); “Quantitative Models of Commercial Policy.” Published in K. Bagwell and R. Staiger (eds) Handbook of Commercial Policy. Amsterdam, Elsevier.

Endnotes

[1] Beshkar and Shourideh (2020).

[2] See Ossa (2016).

[3] See Maggi and Staiger (2011), Beshkar (2010), and Beshkar and Bond (2017) among others.

[4] The logic here is similar to that of Bagwell and Staiger (1990).

 

 

Summary of the 6th InsTED Workshop at the University of Nottingham

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We would like to thank The School of Economics, University of Nottingham, for hosting and sponsoring the 6th InsTED Workshop.  We would also like to thank the Nottingham School of Economics for incorporating The World Economy Lecture into the InsTED Workshop, and Wiley for sponsoring this.  The workshop took place from September 20th-22nd, 2019.  Special thanks go to Roberto Bonfatti, Giovanni Facchini, and Alejandro Riaño as joint chairs of the local organizing committee, and Hilary Hughes for taking care of the local organizational details.

The program comprised of 24 papers ranging over four broad topics at the intersection of institutions, trade and economic development.  The first was factor allocation, productivity, and economic development, focusing on how income shocks are transmitted through distortions in the economy, and how the distortions might be removed to promote development.  The second topic examined trade policies, externalities, and agreements, by developing frameworks that go beyond the conventional two-good or partial equilibrium structures, and introducing the possibility that trade agreements may actually generate negative externalities rather than just removing them.  The third concerned international trade and economic development, again focusing on distortions but this time through trade policies and also labor market institutions such as minimum wages.  The fourth was on political institutions and economic development, focusing on different aspects of the role of democracy on capital formation and growth.

There now follows a summary of all the papers presented at the workshop, organized under the four topic headings above.  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.

Factor Allocation, Productivity, and Economic Development

An influential view in economics holds that the efficient allocation of resources to production is central to the process of increasing productivity and hence economic development.  Following this view, the market-and-institutions approach aims to set institutions and government policies so that development emerges spontaneously through the efforts of individuals.

Income Shocks, Distortions and Development

The first keynote address by Robin Burgess considered the “stubborn poverty” problem: the issue that even as countries build momentum behind growth and development, many people are left behind in poverty.  The purpose of the paper he presented was to understand why some people stay poor even as growth and development take off, with the ultimate objective of designing policies to facilitate the movement of the poorest out of poverty as part of the process of economic development.  Many government policies already exist for this purpose that make available credit, training, and grants to promote entrepreneurship.  In motivating his talk, Burgess argued that we need to understand why people stay poor even when such policies are available in order to evaluate the extent to which policy programs to mitigate poverty can be effective.

In essence, the paper tests between two views of why people stay poor.  According to the first view, there is equal access to opportunity, but people have different innate mental and physical traits that ultimately determine their standard of living.  According to this view, peoples’ allocation of their talents to the production process is efficient, and the only way to lift them out of poverty is through social protection programs facilitated through the development process.  A crucial implication of the fact that the talents of the poor are already efficiently allocated is that making more assets available to them will not help lift them out of poverty in the long run.  According to the second view, it is not variation in peoples’ talents that determines their standards of living but variation in their access to economic opportunities.  The talents of those who lack access to opportunities are consequently misallocated.  A crucial implication of this second view that contrasts with the first is that a capital transfer will help to facilitate the efficient allocation of the talents of the poor, thus helping to lift them out of poverty, and facilitating development in the process.

The test is implemented using a randomized controlled trial that implements a positive shock to capital over 23,000 households across the wealth distribution in Bangladesh over seven years.  Of these, 4,000 households were randomly allocated an endowment of one year’s worth of personal consumption expenditures.  The allocation was the same across households, but households started with different asset baselines due to pre-existing variation.  The surprising result of the study is that households whose asset base is pushed over a threshold are then able to accumulate capital for themselves, while those below the threshold are not.  This suggests the existence of a poverty threshold or ‘trap’, whereby only transfers large enough to push beneficiaries over the threshold will reduce poverty in the long run.  The implications are profound and far-reaching.  Previous tests may have falsely attributed support to the first view of why people stay poor by failing to make transfers that were sufficiently large to push people over the threshold.  And policies and institutional changes to facilitate the availability of credit, say, must make capital available to the poor on a sufficiently large scale to push them past the poverty threshold if they are to move into the range where they can allocate their talents efficiently.

Technological innovations that foster trade integration, especially in shipping technology, create positive income shocks that may reduce conflict, in turn promoting economic growth and development.  The paper presented by Reshad Ahsan tests the first part of this proposition against an impressive 250 year sweep of data spanning 1640-1896.  The paper tests the idea that the decline in intra-European conflict from the late Middle Ages to World War One can be explained partly by the increase in Atlantic trade.  It finds that if any two European countries jointly increase their trade integration with the New World by one standard deviation, then the probability that they will be at war with each other decreases by 12.33 percentage points; an economically significant reduction from a baseline probability of war of 14.3 percent.  The endogeneity of New World integration is addressed using exogenous, weather-based shocks to trade between Europe and the New World.

Climate change represents another kind of shock that, through yield volatility, is having a negative effect on the incomes of poorly insured farmers in developing countries. João Paulo Pessoa presented a paper that examined two different channels through which yield volatility can have an effect on the incomes of poor farmers in India.  The paper develops a general equilibrium framework with portfolio choice to allow farmers to respond to a decline in yields by substituting towards other crops.  The model also captures risk aversion among farmers.  So it can explain how farmers may not substitute away from crops whose average yields decline because they fear greater yield volatility from the crops that they might otherwise have substituted towards.  The model can also capture declines in welfare from the direct effect of increases in the volatility of crop yields.  Despite allowing for these subtleties, they find that the most important negative welfare effects of climate change on poor Indian farmers come through sharp falls in mean crop yields through temperature rises.

Conflict, Misallocation, and Development Failure

If positive income shocks can facilitate development then negative income shocks can certainly precipitate development failure through the onset of intranational conflict and ultimately civil war.  The paper presented by Beatriz Manotas-Hidalgo re-examined the extent to which income shocks cause conflict across Africa, by studying how different types of commodity price shock induced by weather shocks affect the possibility not just of armed conflict but of ‘civilian conflict’ such as riots as well.  Her results confirmed the view that when a society is more ethnically fractionalized, a negative income shock increases the probability of conflict.  But surprisingly, she also showed that while positive agricultural and mineral price shocks increase the probability of civilian conflict, they decrease the probability of armed conflict.  This heterogeneity emphasizes the importance of moving beyond a simple ‘opportunity cost of conflict’ view in seeking to understand how conflict arises.

Hâle Utar presented a paper examining the effects of violence on allocation by focusing on the Mexican drug war.  The drug war brought about a surge in violence as a result of which the homicide rate tripled from 800 to 2400 between 2000 and 2010.  Utar assumes that drug-related violence disrupts the ability of productive factors to allocate to the production process, allowing her to use the homicide rate as an instrument for violence that causes negative income shocks through allocation failure.  Her results show that doubling the homicide rate brings about a 4 percent reduction in plant-level employment, a 6 percent reduction in output, a 2 percent increase in the price level and a 4 percent reduction in productivity.  These magnitudes are significant enough to bring about plant closures and cause long-term damage to the Mexican economy.

Infrastructure, Uncertainty, and Economic Development

It is tempting to think that improvements in infrastructure should always help with the process of economic development by facilitating the efficient allocation of resources across a national economy.  But Niclas Moneke showed that was not the case for Ethiopia when the provision of infrastructure was in the form of a road network that led to the entry of foreign firms that were more productive than domestic ones.  Offsetting this effect, however, was the introduction of an electricity network that allowed domestic manufacturing firms to adopt modern technology, thereby enabling them to adopt modern technology and increase productivity.

Moneke was able to obtain remarkably detailed individual-level occupational choice data for Ethiopia in three waves spanning 1999 to 2016.  To address endogeneity concerns over the location of the electricity network, he exploited plausibly exogenous variation in a location’s electrification status relative to newly opened hydropower dams.  To address endogeneity concerns over the location of the road network, he constructed a least-cost network arising from an implementation of Kruskal’s and Boruvka’s minimum-spanning tree algorithms to solve for a single, purely distance-driven road network that connects all district capitals with at least one road.  From this approach, he was able to present causal evidence that improved transport infrastructure causes decreases in manufacturing employment. But he also showed that this adverse effect of improved market access on manufacturing is reversed via improved productivity with additional access to electricity.

Trade Policies, Externalities, and Agreements

It is now broadly accepted amongst economists that international trade policies can create negative externalities, in which case a key purpose of a trade agreement is to find a way to neutralize those externalities while liberalizing trade in the process.  These insights have been established within the context of classic two-good or partial equilibrium models, wherein trade is assumed to be balanced.

New Trade Policy Models that Go Beyond the Classic Two-Good or Partial Equilibrium Structures

The second keynote address by Giovanni Maggi considered the widespread controversy surrounding so-called ‘deep trade agreements’ such as the Transatlantic Trade and Investment Partnership and the Comprehensive Economic and Trade Agreement.  (Note that the two keynote addresses were sequenced to suit the schedules of our speakers.)  Maggi explained that, according to the dominant paradigm in the economics of trade agreements, unilateral trade policy creates a terms-of-trade externality, and the purpose of a trade agreement is to internalize this externality, thus raising world welfare.  Despite opposition from some quarters, this view underpins the broad sense that ‘shallow trade agreements’ concerning tariffs have broadly been beneficial to the countries that have signed them over the post-World War II period.  However, recently there has been far more controversy around the deep agreements that also impose restrictions on so-called behind-the-border measures such as regulations covering the environment, investment, and labor standards.  Maggi highlighted that this controversy centers on the fact that lobbying by firms appears to be generating externalities of its own through these agreements, rather than agreements neutralizing pre-existing externalities.

Maggi presented a model in which either shallow or deep agreements are possible.  There is a continuum of small countries, which isolates the role of lobbying by ruling out terms-of-trade manipulation by individual countries.  There is also a large number of goods, and each country can produce multiple goods, each from a specific factor with which it is endowed.  Crucially, production and export subsidies are not allowed in his framework, which creates a role for lobbying.  As a baseline, he first considered a model with no domestic distortions.  The outcome in this set-up is a shallow trade agreement involving tariffs only, that increases welfare by pitting exporter interests against import-competing interests. In the non-cooperative outcome, only import-competing interests are represented and this undermines efficiency.  In a shallow agreement, exporter interests are also represented, being pitted against import-competing interests, giving rise to countervailing lobbying.  In effect, in an agreement governments collude to achieve a more efficient distribution that accommodates the interests of exporters, which improves national and global welfare.

His talk then moved on to consider deep agreements and the circumstances under which they may actually undermine welfare.  He did this by first introducing local consumption externalities to the framework, such as local pollution generated by cars.  This provides a rationale for domestic policy intervention and thus creates a role for deep agreements.  In non-cooperative equilibrium, consumption taxes are set at their efficient Pigouvian levels, so anything that causes a change from these levels is bad for welfare.  The cooperative equilibrium of an agreement reduces efficiency since governments collude to favor producers at the expense of consumers.  Second, he replaced the consumption externalities with production externalities, such as local pollution generated by firms.  In this case, the trade agreement pits domestic producers against foreign producers since they have opposing interests regarding domestic taxes.  Assuming that the power of producers is reasonably symmetric, and agreement restores the countervailing feature of lobbying, this time across interest groups in different countries, an agreement can increase welfare.  As Maggi acknowledged, this framework ‘stacks the deck’ against finding positive welfare effects of trade negotiations by ruling out market power and cross-border externalities.  Towards the end of his talk, he introduced terms-of-trade effects and showed that a deep trade agreement will only reduce global welfare if the aggregate political power of producers is sufficiently large to negate the benefit from the agreement of neutralizing the terms-of-trade externalities.

Industrial policy has risen up the policy agenda in many countries recently.  The paper presented by Ahmad Lashkaripour develops a model that makes it possible to consider optimal trade and industrial policy simultaneously in a general equilibrium setting, while the prior literature on industrial policy tends to focus focuses only on a partial equilibrium setting.  Lashkaripour’s model has multiple industries featuring increasing returns to scale, and two types of policy instrument: industry-level export and import taxes, referred to as instruments of trade policy; industry-level production and consumption taxes, referred to as instruments of domestic policy.

The first setting that Lashkaripour explored was one of restricted entry, whereby the number of firms in a given industry is given.  Only the home government is allowed to set policy while the rest of the world remains passive.  In this case, import taxes are shown to be redundant: optimal export taxes are regulated by the industry-level trade elasticity and equal to the optimal mark-up of a multi-product monopolist.  Meanwhile,  optimal production taxes are corrective Pigouvian subsidies that eliminate firm-level mark-up heterogeneity in the local economy.  Surprisingly, when domestic policies are available, optimal trade taxes are identical to those in a competitive model; they do not target the profit-shifting margin.  The next setting was one of free entry.  Here, taxes are able to induce firm delocation across international borders and industries.  As a result, import taxes are no longer redundant and optimal production taxes no longer serve only a basic Pigouvian function.  Instead, the optimal policy reflects the fact that each instrument plays a distinctive role in improving the terms of trade.  An interesting question that can be addressed within this framework is how the unilaterally optimal policy compares to an optimal cooperative policy that eliminates inefficiencies at the global level.  Lashkaripour used his framework to argue that if industry-level trade elasticities are sufficiently large, while scale elasticities exhibit sufficient heterogeneity across industries, then the gains from the cooperative optimal policy will dominate those of the unilateral optimal policy.  This provides conditions under which a country will find it worthwhile to join a deep trade agreement that restricts the use of both types of policy.

Mostafa Beshkar took the discussion of trade agreements in a different direction by relaxing the standard assumption that trade is balanced.  Relaxing this assumption necessitates modelling intertemporal dynamics because allowing for trade imbalances implies exchanging consumption today for consumption in the future.  The framework that Beshkar develops to incorporate these features makes it possible to ask how governments should conduct their trade policy under trade imbalances.  The biggest issue for trade policy raised by the possibility of trade imbalances is the fact that governments can substitute capital controls for trade policy.  Consequently, following the negotiation of a trade agreement, there may be scope for governments to use capital controls to manipulate the terms of trade, thus potentially undermining the trade agreement.  The model that Beshkar presented provides a framework to think through this type of issue.

The framework that Beshkar develops combines two models from the prior literature, one capturing optimal trade policy and the other capturing optimal capital controls to provide a new model that features both types of policy.  This framework can be used to address such issues as the cyclicality of trade policy over time, the interdependence of trade policy and capital controls, and the potential effects of trade imbalances on trade policy.  The framework features a two-country Ricardian model with time-varying labor productivity.  The variation in productivity over time creates a role for international borrowing and lending.  The fact that productivity varies over time creates a role for two instruments to be used simultaneously.  In the absence of capital controls, both import and export taxes are necessary to implement optimal policy: one to manipulate the international terms of trade and the other to manipulate the intertemporal terms of trade.  This contrasts markedly with the static two-good model in which one of these trade taxes would be redundant.  The paper goes on to show that if the use of trade taxes is constrained by an international trade agreement then the government could use capital controls to restore a fraction of its constrained policy space.

While not modelling trade policy directly, the paper presented by Lena Sheveleva provides a new ‘minimal model’ of multi-product firms that can be used to test the implications of trade liberalization on productivity improvements as high productivity firms displace those with low productivity.    In the model, any differences between large and small scope exporters that emerge in the model are due to aggregation across different numbers of products. The proposed model makes it possible to test whether differences between large and small scope exporters are greater than would be expected to arise if firms were just a collection of otherwise unrelated products driven by random variety shocks.  She uses her framework to test whether tougher competition does, in fact, drive multi-product firms to concentrate their sales in the top ranked products even if their scope does not change.  The results she presented showed that once the level concentration implied by randomness is controlled for, the effect of market size on concentration becomes more pronounced both in terms of magnitude and statistical significance, suggesting that reallocation of resources across products in response to trade liberalization shocks may play an even more significant role than previously thought.

WTO Institutional Design

How should the rules of the World Trade Organization (WTO), and its predecessor the General Agreement on Tariffs and Trade (GATT), be designed to maximize the efficiency of outcomes for members, especially in the face of trade shocks that could lead to disputes?  David DeRemer’s paper follows the literature in asking when governments will choose remedies for violation of a trade agreement to ensure compliance with the rules, and when they will choose remedies that allow a breach of the rules but ensure that appropriate compensation is provided to those adversely affected.  The law and economics literature has argued that the former approach defines a ‘property rule’ while the latter defines a ‘liability rule’.  For concreteness, DeRemer couched his discussion in terms of the noteworthy evolution of the majority of non-tariff measures (NTM) from a system of liability rules under the GATT to property rules under the WTO, while actionable subsidies and non-violation complaints have remained as liability rules.

DeRemer’s model features two governments negotiating over several NTMs simultaneously, where each measure operates in a separate market that does not affect the others.  There is a non-cooperative optimal policy that maximizes its government’s payoff function, and a cooperative policy that maximizes the sum of both governments’ payoff functions.  The optimal policies depend linearly on unverifiable shocks to home and foreign preferences.  The paper focuses on the range of the parameter space where there is a conflict of interest between governments over NTMs.  If the difference in the payoffs between cooperative and non-cooperative policies is small, the policy is called a ‘low conflict policy’, and if large it is called a ‘high conflict policy’.  The analysis then focuses on whether the governments should choose a property rule or a liability rule to remedy a violation of an agreement over a particular type of NTM.  Achieving compliance is more difficult on actionable subsidies and non-violations because they are ‘high conflict policies’, and so a larger number of disputes is expected.  Therefore, DeRemer’s framework suggests these policies will be subject to liability rules to minimize the damage done by disputes, explaining what we see in practice.  As for the progression from liability rules in the GATT to property rules in the WTO, the framework suggests this results from increases in gains from coordination over time, relative to the expected costs of disputes, and such coordination gains have indeed occurred due to falling trade costs.

Adam Jakubik considered how WTO rules and flexibilities create a predictable trading environment.  His paper argues that WTO commitments create a predictable trading environment by shaping members’ trade policy responses to import shocks, incentivizing a move away from unilateral tariff increases towards contingent protection, and anti-dumping in particular.  His econometric implementation uses a recently available database of bound tariffs that accounts for countries’ implementation periods and changes of tariff-rate commitments over time, rather than just time-invariant final bindings hitherto used in the empirical literature.  The results he presented showed that as import shocks become larger, countries increase tariffs within the tariff binding, or use contingent measures depending on the level of tariff water. An important implication of their analysis is that the WTO Agreement reduces trade policy uncertainty, not just by setting a maximum allowed tariff, but also by reducing the probability of using tariff water to retaliate.  This is accomplished by providing other flexibilities that are designed to be more predictable, such as tariff bindings that must be removed within a set period of time.

Along similar lines, Michele Imbruno examined how Chinese tariff bindings adopted as part of its entry to the WTO affected Chinese firm-level imports.  The results he presented suggest that a decline in trade policy uncertainty allows Chinese firms to access a greater variety of imported foreign goods, because the payoffs to entering the foreign market are more certain.  The newly available imported goods are also associated with higher quality.  At the same time, tariff bindings prompt more Chinese producers and trade intermediaries to start importing for the first time, thus allowing a greater number of firms and consumers to enjoy potential gains from imports.

International Trade and Economic Development

In classical economics, the removal of distortions created by trade policy represents one of the most significant ways to promote efficient resource allocation and hence economic development.  Recent advances in techniques to causally identify the effects of exogenous trade liberalization shocks, together with the greater availability of data, has made it possible to test for the logic of classical economics in the data.

Trade Distortions and Economic Development

The paper presented by Beyza Ural Marchand looked at the effect of exogenous trade liberalization in Vietnam on intergenerational mobility.  The United States (US)-Vietnam Bilateral Trade Agreement, signed in December 2001, led to an immediate drop in US tariffs against Vietnamese exports of 21 percentage points. The logic underpinning the paper is that while trade liberalization can improve economic efficiency as workers relocate to the expanding export sector, if low intergenerational mobility reflects rigidities in the labor market and workers cannot move, trade liberalization may end up causing an unexpected increase in inequality.  It is, of course, possible that international trade worsens intergenerational mobility by lowering the returns to skills and thus the incentive to invest in education.

The results Marchand presented showed that the reduction in US tariffs applied to Vietnamese exports actually increased intergenerational skill mobility. Interestingly, this effect is visible only for individuals employed in the manufacturing industry and not agriculture and mining. This is consistent with the observation that most of the export expansion was in manufacturing.  In order to further investigate the effect of trade liberalization on human capital investment, she differentiated between the individuals who are the oldest son within households and individuals who have birth order of two or larger. Controlling for education, location, and other labor market characteristics, one should not observe different effects if resources are allocated efficiently within households. The results Marchand presented show that the effect of the export shock on intergenerational mobility is in fact limited to firstborn sons.

Facundo Albornoz’s paper considered a shock going in the opposite direction.  In mid-1997, the US suspended preferential tariff rates on over 100 different imports from Argentina, granted under the generalized system of preferences (GSP) program, affecting over a third of Argentinian exports to the US.  Particularly because this represented retaliation arising from a separate dispute over the protection of intellectual property rights, the tariff increases can plausibly be taken as exogenous.  Comparing the reactions of the firms affected by the suspension with the behavior of firms whose products were unaffected by tariff changes, Albornoz showed that the tariff increase induced some firms to stop exporting to the US market altogether.  Surprisingly, for those firms that continued to export, there was no significant reduction in the volume of their exports because those firms were able to rebalance towards exporting goods that were not affected by the suspension.  So more resilient exporters are able to partially circumvent the tariff increases through a (potentially inefficient) shift of resources across products.  Even more surprising was the finding that essentially all the results obtained for the US market carry through to third markets, where there was no policy change regarding imports from Argentina.

A complementary perspective was provided by Florian Unger in the paper he presented.  He considered the effect of corporate tax reforms on the exports of multi-product firms.  For the Organization of Economic Cooperation and Development (OECD) countries, the average statutory corporate tax rate has fallen from 39.9% in 1990 to 27.5% in 2014.  In contrast to the previous paper, these tax reforms tended to affect all exports of a particular firm equally.  The theoretical model introduces tax policy to multi-product firms.  The model shows that the reduction of the corporate tax rate in a particular destination leads to more intense competition in that location as exporters reduce product scope in that destination, focusing on their better performing products.  The paper tests the predictions of the model using data from the World Bank Exporter Dynamics Database combined with information on corporate tax rates over the period 2005-2012.  The resulting dataset covers firm dynamics in 70 origin countries in all their export destinations, and corporate tax reforms in 49 destination countries.  The results that Unger presented show strong support for our theoretical predictions that a reduction in the destination tax rate reduces the number of exported products, while increasing the exit of exporters to that country.  Moreover, using detailed information on firm export sales by product and destination, he was able to show that a lower corporate tax rate in the destination country increases the within-firm skewness of export sales to that destination, which reinforces the theoretical mechanism.

Yet another perspective was provided by Alejandro Riaño, with his examination of export subsidies in Nepal.  Nepal is the third poorest country in Asia.  Moreover, its exports are highly concentrated among only five HS6-digit products, with 85% of exports going to only five countries, with 80% of these going to India alone.  In 2012, the Nepalese government introduced the Cash Incentive Scheme for Exports (CISE) in order to try to overcome frictions in exporting and thereby increase export diversification.  Accordingly, CISE is an ad valorem cash subsidy to exports of a select group of products available only for exports sold in countries other than India.  The econometrics are based on customs transaction data for the period 2011-2014 combined with information on subsidy payments to individual firms.  The CISE subsidy is available to 24 industrial and 7 agricultural products such as carpets, pashminas, tea, coffee and spices. These products accounted for 41% of total export value in 2011.  The results that Riaño reported show that, relative to the control group, firms that received the subsidy increase the number of destinations (other than India) they sell to by 10-12% and the number of products included in the CISE scheme they export by 6-7%. And just as the theory in his paper predicts, the subsidy did not affect the intensive margin of targeted product-destinations, i.e. average exports per product, destination and product-destination combinations.  But the results suggest that the scheme may not be economically efficient given its high fiscal cost.

While the removal of distortions to trade promotes efficient resource allocation, one of the main channels for rent-seeking in developing countries is through distortions to trade policy.  The paper presented by Adeel Malik is among the first to provide a systematic empirical assessment of the impact of political connections on protectionism.  Focusing on Egypt, it develops a unique dataset to identify, at the international standard industrial classification (ISIC) 4-digit level, which products were being produced by crony firms that had links to the Mubarak regime.  The paper then argues that the events of  ‘September 11th’ exogenously triggered the European Union (EU) to successfully push for a trade deal with countries in North Africa, resulting in the installation of a large number of NTMs on imports.  The key finding of the paper is that crony firms have a much smoother experience with the implementation of NTMs than firms that are not politically connected.  For example, where NTMs involve inspections, inputs imported by crony firms are ‘waved through’ at the border, while those imported by other firms are subjected to long delays.  Thus, the paper breaks new ground by demonstrating the endogeneity of trade distortions to crony influence.

One of the most controversial arguments in the field of international trade is that protection can actually enhance industrial development by shielding a nascent industry from the intensity of competition with established foreign technologies: the so-called ‘infant industry argument’.  Roberto Bonfatti presented a paper that regarded World War I as creating a natural experiment that cut India off from trade with the UK, asking whether this promoted Indian industrial development as a result.  More specifically, the paper explores whether regions in India that were more exposed to the negative trade shock with the UK had a greater propensity to increase their manufacturing output.  It finds that Indian districts that were exposed to a greater fall in net imports from Britain in 1913-1917 did indeed witness a greater increase in industrial employment as a result.  The effect is statistically and economically significant: in the paper’s baseline results, as one moves from the 10th to 90th percentile in exposure to the shock, the share of industrial employment to total population increases, on average, by an extra 12% of the initial value.

Labor Market Distortions, Trade and Development

There is a growing empirical literature arguing that minimum wages do not have adverse employment consequences, challenging conventional wisdom in economics.  In turn, minimum wages have been on the rise, both in level and the degree to which they are enforced.  The paper presented by Xue Bai argues that findings of apparent positive (or not significantly negative) employment effects from minimum wages may arise from the fact that these studies take a partial-equilibrium approach.  Her paper takes a general-equilibrium approach based on the underlying structure of a Heckscher-Ohlin model.  Moreover, it introduces firms that are heterogeneous in their productivity levels, and focuses on the selection effects of minimum wages across all sectors.  The key feature of her model is that the exit of existing firms increases as a result of an increase in the minimum wage in sectors that have a binding minimum wage.  Based on data for China, the paper shows that, as predicted by the model, a binding minimum wage raises product prices, encourages substitution away from labor, though less so for high-skill-intensive and capital-intensive goods, and creates unemployment. Less obviously, it reduces output and exports, especially of the labour-intensive good, despite the price increases.  Least obvious is the prediction, also borne out in the data, that selection in the labour-intensive sector becomes stricter, while that in the capital intensive sector becomes weaker.

While rigidities in the labor market can create unemployment, the existence of an informal sector that doesn’t have these rigidities can provide a buffer that helps to absorb adverse shocks to the economy.  The paper presented by Gabriel Ulyssea focuses on the informal sector in Brazil where firms do not register with the authorities but do perform legal production, and are therefore invisible to the government.  Brazil has a long history of measuring informality through household surveys.  Informality provides greater job availability but no employment insurance to workers, thereby creating ambiguous effects on welfare.  In this environment, Ulyssea’s paper explores the labor market and welfare effects created by globalization shocks.  The framework provides a structural equilibrium model in which counterfactual analysis of the shocks can be performed.  A key finding of the paper is that a stricter crackdown on informality would have led to significantly more adverse welfare effects from the globalization shocks that hit Brazil in the early 1990s.  Their findings suggest that the informal sector does indeed play the role of shock-absorber in the Brazilian economy.

Political Institutions and Economic Development

Economic institutions are not all that matters in the determination of economic development.  An increasingly influential view holds that political institutions are important in the determination of economic institutions and hence economic performance, with particular emphasis on democracy.

Democracy and Economic Development

Marcus Eberhardt presented a paper that explored the robustness of the findings of a recent publication in the Journal of Political Economy by Acemoglu, Naidu, Restrepo and Robinson (ANRR) titled “Democracy Does Cause Growth.”  ANRR show that the long-run effects of democratization are a sizeable increase in per capita GDP of 20% or more. Eberhardt’s analysis relaxes two of the key assumptions that ANRR make, that there is a homogeneous parametric relationship between democracy and growth across all the countries in their sample, and that there is an absence of strong cross-sectional correlation.  His results indicate that the relationship between democracy and growth is in fact heterogeneous.  Specifying instead an alternative empirical approach adopted from the recent panel time series literature that allows for this heterogeneity, he finds that the economic magnitude of democratization on per capita GDP is 10%, thus still substantial but more modest than in the results of ANRR.

A controversial aspect of democracy concerns whether non-nationals have an effect on the outcome of national elections when institutional features are designed to prevent them from doing so.  The paper presented by Michele Valsecchi explored whether sanctions imposed on the Russian Federation by 37 other countries in response to Russia’s annexation of Crimea had an effect on the election of Vladimir Putin to the position of President of Russia in 2018.  As the paper explains, the general intention of sanctions is to cause a policy change by the country against which sanctions are imposed.  This might happen because people are made worse off by the sanctions and recognize that a change of policy would cause the sanctions to be lifted, leading the incumbent to respond accordingly.  Or it might happen because the sanctions make the incumbent so unpopular that they are voted out of power.  Valsecchi’s paper explores the latter possibility.  The paper estimates the relationship between the share of countries imposing a sanction in a region’s total trade or GDP on the change in vote share realized by Putin in the election.  The surprising finding of the paper is that the higher the share of countries imposing a sanction, the more Putin’s vote share increased!  This result supports the widely held opinion amongst economists that sanctions do not achieve their intended outcome of bringing about policy change, and can in fact backfire.

Recent research in political science suggests that the form of government, dictatorship or democracy, may play a role in determining the immigration rights that a country grants.  A dictatorship has an incentive to set lax immigration rights to bid down wages on behalf of capitalists, while a democracy has an incentive to set tight immigration restrictions to keep wages high on behalf of workers.  But this view struggles to explain why democracies are more inclined to grant naturalization rights, allowing immigrants to become citizens, while dictatorships are not.  The paper presented by Ben Zissimos put forward a model that provides an explanation.

The model adapts to an immigration setting a popular argument in economics that the purpose of a trade agreement is to enable the government to tie its hands against lobbying by protectionist pressures from interest groups.  The government would want to do this if the short-run compensation from lobbying is not sufficient to compensate it for the long-run distortions created, for which it is not compensated.  Drawing on this logic, the model that Zissimos presented could be used to show that the government may be better off committing to an institution that supports immigration in the long term, i.e. naturalization, thereby shutting down lobbying over immigration to some degree.  Moreover, the weaker is the government’s bargaining power, the lower is its short-run compensation from lobbying and so the more likely it is to gain from naturalization.  Crucially, a government will have less bargaining power vs the lobby if it is a democracy than a dictatorship.  The reason is that democracies typically have less bargaining power in an institutional environment where they are also constrained by the rule of law, while dictatorships are not typically so constrained.

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

Reshad N. Ahsan, Laura Panza and Yong Song “Atlantic Trade and the Decline of Conflict in Europe: Evidence from 250 Years of Data”

Facundo Albornoz, Irene Brambilla, and Emanuel Ornelas “The Impact of Tariff Hikes on Firm Exports”

Xue Bai, Arpita Chatterjee, Kala Krishna and Hong Ma “Trade and Minimum Wages in General Equilibrium: Theory and Evidence“

Mostafa Beshkar and Ali Shourideh “Optimal Trade Policy with Trade Imbalances“

Roberto Bonfatti and Björn Brey “Trade Disruption, Industrialisation, and the Setting Sun of British Colonial Rule in India“

Oriana Bandiera, with Clare Balboni, Robin Burgess, Maitreesh Ghatak and Anton Heil “Why Do People Stay Poor?“

Francisco Costa, Fabien Forge, Jason Garred and João Paulo Pessoa “Hedging Climate Change: Yield Volatility, Crop Choice and Trade”

Fabrice Defever, José-Daniel Reyes, Alejandro Riaño and Gonzalo Varela “All These Worlds are Yours, Except India: The Effectiveness of Cash Subsidies to Export in Nepal“

David R. DeRemer “Agreements and Disputes over Behind-the-Border Non-Tariff Measures”

Rafael Dix-Carneiro, Pinelopi K. Goldberg, Costas Meghir, and Gabriel Ulyssea “Trade and Informality in the Presence of Labor Market Frictions and Regulations“

Markus Eberhardt “Democracy Does Cause Growth: Comment“

Ferdinand Eibl and Adeel Malik “The Politics of Partial Liberalization: Cronyism and Non-Tariff Protection in Mubarak’s Egypt“

Lisandra Flach, Michael Irlacher, and Florian Unger “Corporate Taxation, Multi-Product Firms, and International Trade“

Atisha Ghosh and Ben Zissimos “The Political Economy of Immigration, Investment, and Naturalization”

Roberg Gold, Julian Hinz, and Michele Valsecchi “To Russia with Love? The Impact of Sanctions on Elections”

Michele Imbruno “Importing under trade policy uncertainty: Evidence from China”
Note that Michele told us his paper had been accepted for publication after submission to the workshop and we were nevertheless happy to keep the paper on the program.

Adam Jakubik and Roberta Piermartini “How WTO Commitments Tame Uncertainty”

Ahmad Lashkaripour and Volodymyr Lugovskyy “Scale Economies and the Structure of Trade and Industrial Policy“

Giovanni Maggi and Ralph Ossa “Are Trade Agreements Good for You?“

Beatriz Manotas-Hidalgo, Fidel Pérez-Sebastián, and Miguel Angel Campo-Bescós  “Reexamining the Role of Income Shocks and Ethnic Cleavages on Social Conflict in Africa at the Cell Level“

Devashish Mitra (Syracuse University), Hoang Pham (Syracuse University), Beyza Ural Marchand “Skills and International Trade: Intergenerational Mobility in Vietnam”

Niclas Moneke “Infrastructure and Structural Transformation: Evidence from Ethiopia“

Lena Sheveleva “Minimal Model of Multi-product Firms“

Hâle Utar “Firms and Labor in Times of Violence: Evidence from the Mexican Drug War“

 

The MALYNES Project

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Migration and Labor Supply when Culture Matters

By Simone Moriconi and Thomas Baudin

The objective of the “Migration And Labor supplY wheN culturE matterS” (MALYNES) project is to propose an encompassing framework suited to predict the future effects of migration on labor supply in the European Union. MALYNES pursues this general objective following a three-fold strategy. First, it wants to create knowledge about future scenarios regarding labor mobility and migration in Europe. These scenarios depend on natives’ perceptions of the value of immigration, and political support towards an open migration policy. Second, it applies well-known empirical approaches from the cultural economics literature to the detailed information available from European time use and register data. In this way, it derives a cross-cultural “map” of the most important values and preferences (many of them related to family behaviors) that affect the individual labor supply decision. Third, it develops a quantitative theory for the impact of migration on labor supply. The model incorporates cultural differences as a key ingredient of behaviors like fertility, marriage and time use of both migrant and native families in a wide variety of European countries. We estimate the parameters of the model using structural estimation techniques.

To find out more, click here

Making Globalization More Inclusive

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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

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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).

Economic Shocks and Crime: Evidence from the Brazilian Trade Liberalization

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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

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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).

 

Financial Constraints, Institutions and Foreign Ownership

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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.

References

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: https://doi.org/10.1016/j.jinteco.2019.01.008.

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.

Endnotes

[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).