Category Archives: Institutions

The WTO and Economic Development

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Ben Zissimos (University of Exeter Business School)

My new edited volume tilted The WTO and Economic Development, brings together a collection of perspectives on different aspects of the purpose and institutional design of the World Trade Organization (WTO), and how these relate to economic development.[1]  The perspectives are contributed by a group of leading scholars in the economics of international trade.  The role that the WTO and its progenitor, the General Agreement on Tariffs and Trade (GATT), have played to date in facilitating economic development, and the role that the WTO can reasonably be expected to play in the future, is the unifying theme.

The following summary is based on my introductory chapter, which presents a synthetic literature review to develop context for the contributions that follow and draws basic insights.

Chapter 1, by Robert Staiger, sets out a comprehensive framework for formally incorporating non-tariff measures (NTMs) into a model for analyzing a multilateral trade agreement, taking tariffs into account as well.  The chapter notes that while developing countries tend to impose border NTMs on imports from developed countries, developed countries tend to impose behind-the-border NTMs on imports from developing countries.  A key contribution of the chapter is to show that an agreement involving border-NTMs is in fact amenable to a terms-of-trade motivation.  Since border-NTMs can exert a negative terms-of-trade externality on trade partners, by causing a reduction in demand for their exports, an agreement over border-NTMs has the same motivation of escaping from a terms-of-trade externality as in the conventional tariff-based ‘terms-of-trade theory’ of trade agreements.[2]

Chapter 2, by Chad Bown, adopts a more traditional focus on tariffs.  The motivation is compelling, arguing that there are 3.5 billion people in the world who have yet to benefit from an agreement to lower tariffs under the GATT/WTO, the overwhelming majority of whom are in developing countries.  The chapter tests for developing countries an implication of the terms-of-trade theory of trade agreements that has been shown to hold in developed countries.  The implication focused on in the chapter is that, through WTO negotiations, members are requested to take on lower tariff binding commitments in products for which they have higher market power, and thus where their tariffs (if left unchecked) would result in larger terms-of-trade externality losses for trade partners.  The chapter identifies well-defined groups of developing countries for which the implication holds, and groups for which it does not, showing that the terms-of-trade theory is relevant to developing-country trade liberalization through trade agreements but is not the only motivation.

Chapter 3, by Rodney Ludema, Anna Maria Mayda, and Jonathon McClure, studies the evolution of the so-called ‘MFN free rider problem’, an implication of the terms-of-trade theory.  In their earlier work, Ludema and Mayda show that an exporting country’s benefit from an MFN tariff concession by another country is proportional to exporter concentration.[3]  An exporting country’s willingness to pay for an MFN tariff concession on the product it exports with tariff concessions of its own depends on how much its refusal to offer concessions would reduce the MFN tariff concession.  The smaller the exporter, the less its refusal would mitigate the tariff cut, and thus the less costly it would be for the exporter to refuse to make a concession, thus free-riding on the concessions of other countries.  An intriguing contribution of the chapter is to show that, through the growth of trade with emerging economies such as China since 1993, the MFN free rider effect is found to have gotten worse.

Chapter 4, by Xuepeng Liu, considers a puzzle concerning so-called non-member participants (NMPs).  NMPs consist of three groups: colonies and overseas territories of GATT members; newly independent states; and provisional members.  NMPs are relevant here because they tend overwhelmingly to be developing countries.  The first econometric literature on the effects of the GATT/WTO explores whether member countries really have different trade patterns than outsiders, thus assessing the effectiveness of the GATT/WTO in liberalizing trade.[4]  The literature shows that they do, but in the process finds an ‘NMP puzzle’: while two formal GATT members trade 61 per cent more than the baseline case of neither country being a formal member nor an NMP, two NMPs trade 140 per cent more than the baseline.  It is counterintuitive that the NMPs should trade even more than formal members.  Chapter 4’s main contribution is to show that the ‘NMP puzzle’ can be resolved by undertaking two relatively simple modifications to the original gravity equation approach of the prior literature.

In Chapter 5, David DeRemer develops a model for analyzing a trade agreement when autarky is the (unique) outcome of non-cooperation over trade policy.  While the canonical model of trade agreements with perfect competition and political economy has proved to be powerful and flexible in explaining many aspects of trade liberalization under the GATT/WTO, it cannot motivate a trade agreement of the kind that DeRemer considers.[5]  Specifically, in the canonical model, if each government has a unilateral preference for autarky then they must have a joint preference for autarky as well.  This limits the scope for studying situations where developing countries have adopted autarkic trade policies for specific sectors, but where there may nevertheless be scope to open these sectors as part of a trade agreement.  For example, developing countries have commonly produced busses and trucks domestically behind high tariff walls.  The chapter adopts a familiar ‘Brander-Spencer’ type model in which to motivate and explore the scope for a trade agreement when autarky is the non-cooperative outcome.

Chapter 6, by Fabrice Defever and Alejandro Riaño, looks at the export promotion policies implemented by China, and how these have promoted the transition of China from autarky in the 1970s to the world’s largest exporting economy today.  The point of departure for this chapter is a set of stylized facts on firm exporting behavior that has been established in the economics literature for the world’s major trading economies: relatively few firms engage in exporting; exporting firms tend to be more productive and hence larger; most firms that do export sell only a small fraction of their output abroad.[6]  The chapter reveals that, on the face of it, the characteristics of Chinese exporters fit the stylized facts listed above. The most striking difference, the chapter finds, is that a third of firms export almost all of their output: China is thus characterized as having a ‘dual export sector’.  The overall conclusion of the chapter is that China’s export promotion policies have been responsible for creating its dual export sector, and have been instrumental in China becoming the world’s largest exporter.

Chapter 7, by Eric Bond, considers whether an efficient trade agreement should allow for gradual trade liberalization to mitigate adjustment costs.  Recent research has shown that the adjustment costs of moving productive resources between sectors in response to trade liberalization are significantly higher than previously thought.[7]  These costs are likely to be particularly high for developing countries, where adjustment is likely to involve geographical relocation between rural and urban settings.  The analytical approach taken in Chapter 7 is to examine the optimal liberalization path between two large countries, where workers face adjustment costs of moving between sectors.  The results show that if tariffs are the only policy instruments available, then developing countries should be allowed longer phase-in periods if their marginal costs of adjustment are higher than in developed countries.  Hence, the analysis shows that there may be a normative justification for so-called ‘special and differential treatment’ of developing countries.

Chapter 8, by Eric Bond and Kamal Saggi, contrasts the roles of price controls and compulsory licensing (CL) to improve consumer access to patented foreign products in developing countries.  While the Trade Related Aspects of Intellectual Property Rights (TRIPS) agreement created a storm of controversy, the eye of the storm was over the implication that, as a result of the agreement, it became more difficult for poor people in developing countries to access medicine at affordable prices.  Under the terms of the TRIPS agreement, if a patent holder refuses to grant access to its product on ‘reasonable’ commercial terms then a government may grant a CL to a different firm to produce the product.  The main lesson of the chapter is that the social value of CL depends crucially on entry costs and the size of the market, and is ambiguous.  This ambiguity seems to be a feature of outcomes under the TRIPS agreement more broadly, making it difficult to assess the extent to which it is beneficial or harmful overall.

The ninth and final chapter, by Mostafa Beshkar and Mahdi Majbouri, tests empirically the outcomes of disputes, focusing on whether or not they lead to litigation, taking explicit account of whether or not the dispute involves developed and/or developing countries.  The chapter focuses on the fact that developing and developed countries show divergent behavior in the dispute settlement process.  A surprising pattern uncovered in Chapter 9 is that, in a dispute between a developed and a developing country, litigation is more likely if the developed country is the defending party.  As detailed in the chapter, 62 per cent of disputes in which a developed country presses charges against a developing country are settled without establishing a dispute panel. In contrast, only 44 per cent of disputes are settled without establishing a dispute panel if a developing country mounts a dispute against a developed country.  Importantly, the chapter shows econometrically that this asymmetry disappears after 2001, when the Advisory Centre on WTO Law (ACWL) was established to make available advice and subsidies to poorer countries, to help them with the costs of mounting a WTO dispute.

References

Bagwell, K., and R.W. Staiger, (1999); “An Economic Theory of the GATT.”  American Economic Review 89: 215-248.

Bagwell, K., and R.W. Staiger, (2002); The Economics of the World Trading System.  MIT Press, Cambridge (Mass), US.

Bernard, A.B., J.B. Jensen, S.J. Redding, and P.K. Schott, (2007); “Firms in International Trade.” Journal of Economic Perspectives 21(3): 105-130.

Dix-Carneiro, R., (2014); “Trade Liberalization and Labor Market Dynamics.” Econometrica 82(3): 825-885.

Ludema, R., and A.M. Mayda, (2009); “Do Countries Free Ride on MFN?” Journal of International Economics 77(2): 137-150.

Ludema, R., and A.M. Mayda, (2013); “Do Terms-of-Trade Effects Matter for Trade Agreements? Theory and Evidence from WTO Countries.” Quarterly Journal of Economics 128(4): 1837- 1893.

Melitz, M.J., and S.J. Redding (2014); “Heterogeneous Firms and Trade.” Handbook of International Economics, 4th ed, 4: 1-54.

Rose, A., (2004); “Do We Really Know That the WTO Increases Trade?” American Economic Review 94(1): 98-114.

Tomz, M., J.L. Goldstein, and D. Rivers, (2007); “Do We Really Know That the WTO Increases Trade? Comment.”  American Economic Review 97(5): 2005-2018.

Zissimos, B., (forthcoming) The WTO and Economic Development, accepted for publication by MIT Press, Cambridge (Mass), US.

Endnotes

[1] See Zissimos (forthcoming).  The MIT Press have kindly allowed me to post the full text of this volume on my website until the book appears in print.  Please see the above reference for a link.

[2] See Bagwell and Staiger (1999, 2002).

[3] See Ludema and Mayda (2009, 2013).

[4] See Rose (2004), and Tomz, Goldstein and Rivers (2007).

[5] The canonical model is due to Bagwell and Staiger (1999, 2002).

[6] See Bernard, Jensen, Redding and Schott (2007), and Melitz and Redding (2014).

[7] See Dix-Carneiro (2014).

(When) Do Anti-poverty Programs Reduce Violence? India’s Rural Employment Guarantee and Maoist Conflict

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Aditya Dasgupta (University of California, Merced), Kishore Gawande (University of Texas, Austin), and Devesh Kapur (Johns Hopkins University – SAIS)

More than half of all nations have experienced a violent civil conflict since 1960.[1] One of the best predictors of conflict outbreak in a country is a low level of economic development and whether it has experienced a civil conflict in the past, suggesting the existence of “conflict trap” in which poverty and violence reinforce one another over time. This begs the question: how do nations break out of the vicious cycle of poverty and violence?

Poverty encourages participation in armed civil conflict in at least two ways. First, it creates economic and political grievances among impoverished groups, providing fertile ground for rebel groups to draw support from those who feel neglected by the state. Second, a lack of employment opportunities and stable livelihoods reduces the opportunity costs of participating in violent conflict, making it easier for rebel groups to recruit fighters.

If poverty fuels violence, then anti-poverty programs ought to play an important role in pacifying violent civil conflict. A large and growing scholarly literature has examined this policy implication, coming to surprisingly mixed conclusions. One randomized study of Afghanistan’s largest development program finds that the program contributed to a modest reduction in violence.[2] Another important randomized study in Liberia found that a combination of cash payments and therapy produced a durable reduction of participation in crime and violence among at-risk young men.[3] Other studies, especially those that examine the roll-out of large-scale government programs and not pilot experiments, have found that foreign aid and development programs are sometimes associated with increases in violence.[4]

How do we reconcile the conflicting evidence, especially the disjuncture between micro-level randomized studies by researchers and the program evaluation literature? We argue that state capacity, or the bureaucratic capacity of a government to successfully implement programs, may play an important role in actuating the pacifying effects of anti-poverty programs. In conditions of low state capacity, program funds are unlikely to pass through to local populations and corruption may even reinforce local grievances with the state and provide opportunities for rebel financing. When local state capacity is strong, however, antipoverty programs have a better chance of actually reducing poverty, improving perceptions of the state, and dis-incentivizing participation in deadly conflict.

To examine this hypothesis, we empirically examine how the roll-out of India’s National Rural Employment Guarantee Scheme (NREGS), a large-scale anti-poverty program which guarantees every rural household in India up to 100 days of public works employment, affected the intensity of the Maoist conflict, a protracted conflict between a Maoist insurgency concentrated in eastern India and the Indian government. Because the roll-out of NREGS was staggered in three phases between 2006 and 2008, we can employ a difference in differences research design. If NREGS reduced violence, we should observe a reduction in violence in districts adopting the program relative to districts experiencing no change in their program adoption status. Moreover, if these pacifying effects depended on state capacity, we should observe that these effects are mainly concentrated in districts with a high level of state capacity, which varies quite substantially across regions and districts of India.

To measure the intensity of the Maoist conflict, we assemble a new panel dataset of violent incidents and deaths at the district level, drawing on the archives of local language newspapers, which ensures that we get adequate temporal and spatial coverage of a long-simmering conflict that occurs mainly in rural areas; existing datasets that draw exclusively on English language sources are heavily biased toward more recent conflict events and those that are close to urban areas. To measure district-level state capacity, we average the ranking of districts across four indicators of basic service provision according to the 2001 census based on the share of villages with: (1) a paved road; (2) a primary school; (3) a primary health center; and (4) an agricultural credit cooperative (the lowest tier of the Indian government’s agricultural credit network).

Using these data, we come to two main findings. First, overall the adoption of NREGS was associated with a large reduction violent incidents and deaths, especially over the long run. To provide a back-of-the-envelope calculation of the size of the pacifying effects, consider the total levels of violence observed in 2008: 619 violent incidents resulting in 751 deaths. According to our regression estimates, counter-factually without the adoption of NREGS across districts, levels of total violence would have been 1,440 violent incidents resulting in 2,030 deaths suggesting that the program eliminated roughly 821 potential violent incidents and 1,279 casualties across districts in that year.

Second, these effects were concentrated in districts with high levels of state capacity. Our analysis of heterogeneous effects suggests that the violence-reducing effects of NREGS were concentrated almost entirely in the top two quartiles of districts in terms of state capacity. In the districts in the bottom two quartiles of state capacity, the program had essentially no impact on violence at all.

What conclusions do we draw? First, NREGS has probably played an important role in the long-term pacification of the Maoist conflict in India. Second, one reason for the mixed evidence from the program evaluation literature on the impact of development programs on violence is that the pacifying effects of anti-poverty programs depend heavily on state capacity, which can vary considerably across and within countries. Indeed, other recent studies have come to similar conclusions – that development programs can reduce violence, but primarily in areas where the state possesses a monopoly of violence and has the capacity to carry out its developmental activities without rebel subversion.[5]

To reduce violence, therefore, policymakers need to encourage not only development through anti-poverty programs, but also the strengthening of bureaucratic and state capacity.

References

Beath, A., F. Christia, and R. Enikolopov, (2013); “Winning Hearts and Minds Through Development: Evidence from a Field Experiment in Afghanistan.” Paper presented at the 110th Annual Meeting of the American Political Science Association, August, Chicago.

Blattman, C., J.C. Jamison, and M. Sheridan, (2017); “Reducing Crime and Violence: Experimental Evidence from Cognitive Behavioral Therapy in Liberia.” American Economic Review 107(4): 1165-1206.

Blattman, C., and E. Miguel, (2010); “Civil war.” Journal of Economic Literature 48(1): 3-57.

Crost, B., J. Felter, and P. Johnston, (2014); “Aid Under Fire: Development Projects and Civil Conflict.” American Economic Review 104(6): 1833-56.

Sexton, R., (2016); “Aid as a Tool Against Insurgency: Evidence from Contested and Controlled Territory in Afghanistan.” American Political Science Review 110(4): 731-749.

Endnotes

[1] Blattman and Miguel (2010).

[2] Beath, Christia, and Enikolopov (2013).

[3] Blattman, Jamison, and Sheridan (2017).

[4] Crost, Felter, and Johnston (2014).

[5] Sexton (2016).

 

Heterogeneous Effects of Economic Integration Agreements

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By Scott L. Baier (Clemson University), Jeffrey H. Bergstrand (University of Notre Dame), and Matthew W. Clance (University of Pretoria)

It is now widely accepted that economic integration agreements (EIAs) and other trade-policy liberalizations contribute to nations’ economic growth and development. EIAs have proliferated among North-North (N-N), North-South (N-S), and South-South (S-S) country-pairs. While such agreements inevitably alter distributions of income within countries, for the most part EIAs are believed to raise economic welfare. A major recent advance in the international trade literature — in the wake of and building upon theoretical developments associated with firm heterogeneity and export fixed costs — is the development of the “new quantitative trade models.”[1] These models provide calculations of general equilibrium trade and welfare effects of trade liberalizations using exogenous (variable-cost) “trade elasticities” estimated from structural gravity equations combined with aggregate bilateral trade data. Moreover, estimates of welfare effects of EIAs can be computed once one has partial treatment effects from a properly specified gravity equation with EIA dummy variables and an exogenous trade-elasticity (parameter) value.[2]

However, an important unresolved and hardly explored issue is whether — and by what factors — trade elasticities with respect to trade-policy changes vary across time and space, that is, are sensitive to “particular settings”; this is particularly important in contrasting trade elasticities for N-N, N-S, and S-S EIAs. In a recent study, we address three particular questions related to this issue.[3] First, how are trade elasticities — fixed-cost-trade-policy trade elasticities as well as variable-cost ones — theoretically related to levels of fixed and variable trade-cost variables, which vary dramatically between N-N, N-S, and S-S pairs? Second, is there convincing empirical evidence supporting these theoretical interactions? Third, how important quantitatively is the heterogeneity in partial equilibrium trade impacts in determining the general equilibrium welfare impacts of trade-policy liberalizations?

To address these questions, we provided three contributions. First, we extended a standard Melitz model of trade to show theoretically how extensive-margin, intensive-margin, and trade elasticities are endogenous to the levels of theoretical bilateral variable and fixed, policy and non-policy trade costs — even with CES preferences and with an untruncated Pareto productivity distribution.[4] Among several theoretical results, we note three. While the intensive-margin elasticity of tariff rates is sensitive only to the relative levels of variable policy and non-policy trade costs, the extensive-margin elasticity is sensitive also to the relative importance of bilateral endogenous export fixed costs (via network effects) in total bilateral export fixed costs. While the intensive-margin elasticity of policy export fixed costs is zero, the extensive-margin elasticity of policy export fixed costs is sensitive to the relative importance of bilateral endogenous export fixed costs in total bilateral export fixed costs as well as the relative importance of exogenous policy export fixed costs to exogenous non-policy export fixed costs. The theoretical comparative statics provide numerous predictions about how proxies for (time-invariant exogenous) natural variable trade costs and policy and non-policy export fixed costs influence the expected partial effects of EIAs on intensive margins, extensive margins, and bilateral trade.

Second, we evaluated empirically our theoretical hypotheses. We provided empirical evidence confirming our theory and demonstrated the heterogeneity of EIAs’ trade effects depending upon country-pairs’ geographic, cultural, institutional, and development characteristics. Extending earlier work, this is the first study to show evidence that extensive-margin, intensive-margin, and trade-flow EIA elasticities are indeed sensitive to levels of (observable) bilateral variable and fixed, policy and non-policy trade costs in a manner consistent with theoretical comparative statics.[5] Trade elasticities with respect to trade-policy changes do vary across “particular settings.” Geographic, cultural, institutional, and development country-pair characteristics all significantly influence the extensive margin elasticity, whereas primarily geographic variables (distance and adjacency) influence the intensive margin elasticity, consistent with our theory.

Finally, our framework allows us to put to ex ante use the partial effects of EIAs. By explaining the heterogeneity of EIAs’ effects according to theoretically-motivated factors, one can use the heterogeneous partial (treatment) effects for ex ante predictions and we demonstrate empirically that the partial effect of an EIA tends to be much larger for a pair of developing economies. Moreover, in the context of the new quantitative trade models, we demonstrate empirically using two approaches how sensitive quantitatively general equilibrium welfare effects of EIA liberalizations are to the bilaterally heterogeneous (partial) trade elasticities. In one approach, we calculate the general equilibrium welfare effects for importers of 1,358 bilateral EIA liberalizations among N-N, N-S, and S-S country-pairs. Consistent with theory, we show that 98-99 percent of the variation in these 1,358 welfare changes can be explained by the variation in two statistics: the estimated pair-specific bilateral EIA partial (treatment) effect and the share of the importer’s national expenditures on exports from the EIA partner. In the other approach, we show that the probability of two countries having an EIA — which in the context of a theoretical model is related to the net welfare gain from such EIA — is highly correlated with the heterogeneous EIA coefficients and the trade shares.[6] Our results suggest that a 10 percent lower average per capita income of a country-pair is associated with a 60 percent higher partial (trade) effect of an EIA. We close our study by demonstrating the relevance of our findings to the current trade-policy debate, analyzing the partial effect of “Brexit” from the European Union (EU), as well the potential effects of two EU members that are developing economies exiting the EU.

References

Arkolakis, C., A. Costinot, A. Rodriguez-Clare, (2012); “New Trade Models, Same Old Gains?” American Economic Review, 102 (1), 94-130.

Baier, S., and J. Bergstrand, (2004); “Economic Determinants of Free Trade Agreements.” Journal of International Economics, 64 (1), 29-63.

Baier, S., J. Bergstrand, and M. Clance, (2018); “Heterogeneous Effects of Economic Integration Agreements.” Journal of Development Economics, 135, 587-608.

Baier, S., J. Bergstrand, and M. Feng, (2014); “Economic Integration Agreements and the Margins of International Trade.” Journal of International Economics, 93 (2), 339-350.

Costinot, A., and A. Rodriguez-Clare, (2014); “Trade Theory with Numbers.” In Handbook of International Economics, Volume 4, edited by G. Gopinath, E. Helpman, and K. Rogoff. Elsevier Science: Amsterdam.

Head, K., and T. Mayer, (2014); “Gravity Equations: Workhorse, Toolkit, and Cookbook.” In Handbook of International Economics, Volume 4, edited by G. Gopinath, E. Helpman, and K. Rogoff. Elsevier Science: Amsterdam.

Melitz, M., and S. Redding, (2015); “New Trade Models, New Welfare Implications,” American Economic Review, 105 (3), 1105-1146.

Novy, D., (2013); “International Trade without CES: Estimating Translog Gravity,” Journal of International Economics, 89 (2), 271-282.

Endnotes

[1] See Arkolakis, Costinot, and Rodriguez-Clare (2012), Head and Mayer (2014), and Costinot and Rodriguez-Clare (2014).

[2] See Head and Mayer (2014).

[3] See Baier, Bergstrand, and Clance (2018).

[4] Novy (2013) generated endogenous trade elasticities by assuming transcendental logarithmic preferences and Melitz and Redding (2015) generated endogenous trade elasticities by assuming a truncated Pareto productivity distribution.

[5] See Baier, Bergstrand, and Feng (2014) and Head and Mayer (2014) for earlier work.

[6] See Baier and Bergstrand (2004) for underpinnings on this methodology.

Community-Based Action to Fight Corruption

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By Avinash Dixit (Princeton University)

How should a country fight corruption? Most people would answer that the government should make and enforce strong laws against it. But further thinking should show that this approach won’t get far. The politicians who make laws, and the officials who enforce them, all stand to benefit from the prevailing corrupt system. One cannot expect them to go against their strong self-interest. They will make weak laws with loopholes; their enforcement will be lax and itself riddled with corruption. At a minimum, formal legal avenues must be supplemented by participatory and organized efforts of the losers – citizens. Participatory because mere voting is not enough; even if a corrupt government is voted out, the new one will act with the implicit motto: “It is now our turn to eat”. Organized because any one citizen or firm is helpless when a politician or official demands a bribe, but collectively they have a lot of power. The question is how to harness it effectively.

This is a prisoners’ dilemma for consumers and businesses. If no one else is giving bribes, you improve your chances by bribery; if everyone else is complicit in bribery, you will only hurt yourself if you refrain. So bribery is the dominant strategy for all. But when everyone chooses it, in the aggregate they merely cancel one another’s actions and transfer money to politicians and officials. Social scientists have observed and theorized about numerous ways to resolve prisoners’ dilemmas using bottom-up, self-enforcing strategies. We can deploy this knowledge and experience to devise community-based action against corruption.

We know that successful collective action to resolve prisoners’ dilemmas requires: (1) a group with stable ongoing relationships, (2) common knowledge of what constitutes cooperation and cheating, (3) common knowledge of the sanctions to be imposed on cheaters, (4) good detection of cheating, (5) good communication of incidents of cheating to all participants, (6) incentives for members to take their designated action to punish a cheater.[1]

A business community can establish a “no bribery” norm and enforce it using the sanction that anyone found violating it would be ostracized by the others, which would cut him/her off from all the interactions – contracts, supply chains, finance and so on – that any business needs to function in today’s economies.

Let us see how this meets the desiderata listed above.[2]

(1) The community should have some organized structure such as a Chamber of Commerce, which a business is required to join in order to benefit from networking and trade relations, or be on a list qualified to bid for government business.

(2) Members must pledge not to attempt bribery to win any government contracts or licenses or to influence the decisions of regulators, legislators, and courts.

(3) Any member found violating the norm is subject to ostracism by others. This means cutting off business contacts, but can also include social ostracism if the Chamber has a social branch where the families of businesspeople meet. No one wants their spouses and children excluded from social activities of friends, so this threat can be very effective. But experience shows that sanctions should be graduated, not drastic ones triggered by small infractions; therefore violations especially by new and small members should be met first with warnings, and escalate to full ostracism only if they persist.

(4) The Chamber should have a good gossip network, and contacts with media and officials, that enable it to sniff out corruption, and a tribunal that can investigate suspicions or allegations of corruption. This can be supplemented by a more formal research unit that gives ratings to firms for their clean or corrupt behavior, similar to the Michelin star ratings for restaurants. It is extremely important to avoid false accusations, under severe penalties against anyone found making them. It is also important that the tribunal is not perceived as an insiders’ club that serves to exclude newcomers. A broad outside representation of respected senior retired businesspeople, public figures, media personnel, and academics should oversee the working of the tribunal.

(5) The name and picture of anyone convicted of violating the norms should be publicized widely, as done by the famous New York Diamond Merchants’ Club.[3]

(6) A system like the Honor Codes against cheating that exist in some universities, where refusing to report a violation is itself a violation requiring similar sanction, can create an incentive to take part in the ostracism of a convicted briber. But more than that: If A is ostracized by everyone and invites B to deal with him, B knows that A has nothing worse to fear by cheating in their interaction, and therefore that he must give up a bigger share of the available joint profit or rent to A to keep him honest. In other words, it is more costly to deal with a convicted briber than with someone who has a clean record.

The prisoners’ dilemma view of corruption can be supplemented by a coordination game.[4] Societies have two kinds of equilibria, one where everyone is corrupt and that is just an accepted state of affairs, and another with a clean culture where corruption is shameful and rare. How to shift from a corrupt to a clean equilibrium? Try harnessing the idealism of youth. Everywhere the young, especially the best educated and most enterprising, want their country to be modern and corruption-free. Other things reasonably equal, they prefer to work for, and buy from, firms with good governance and ethical behavior. A movement that channels these preferences into action can create an environment in which such clean firms attract the best talent, are favored by consumers, and therefore are more profitable; this builds momentum for more and more firms to eschew corruption. Indeed, such an organization is having some success in Sicily to fight the Mafia’s extortion; bureaucrats should be easier to counter.[5]

I am not claiming that such organizations or movements will successfully eliminate corruption everywhere, or quickly, or completely. But corruption is such an obstacle to development that even a little success is worth having. Nothing else has worked at all well. Waiting for a 100% effective solution only ensures getting 0% progress.[6]

Suggestions for further reading

Transparency International, (2016); The Benefits of Anti-Corruption and Corporate Transparency.  Working Paper #01/2016.

Mungiu-Pippidi, A. (2015); The Quest for Good Governance: How Societies Develop Control of Corruption. Cambridge University Press.

Basu, K., and T. Cordella (eds). (2018); Institutions, Governance, and the Control of Corruption, Palgrave Macmillan.

References

Bernstein, L., (1992); “Opting out of the legal system: Extralegal contractual relations in the diamond industry.” Journal of Legal Studies, 21(1), 115–57.

Dixit, A., (2004); Lawlessness and Economics: Alternative Modes of Governance, Princeton University Press.

Dixit, A., (2017); “Fighting corruption by altering the equilibrium in an assurance game.” working paper, November 2017, available at http://www.princeton.edu/~dixitak/home/wrkps.html

Dixit, A., (2018); “Anti-Corruption Institutions: Some History and Theory.” Published in K. Basu and T. Cordella, (eds.) Institutions, Governance, and the Control of Corruption, Palgrave Macmillan, pp. 15-49.

Dixit, A. and R. Mankar (2018); “New ideas for fighting corruption in India,” LiveMint, April 23, 2018, https://www.livemint.com/Opinion/mxVdMVeQUBEfoJWmY0scRL/New-ideas-for-fighting-corruption-in-India.html .

Dugatkin, L., (1999); Cheating Monkeys and Citizen Bees: The Nature of Cooperation in Animals and Humans, Harvard University Press, 1999

Greif, A., (2006); Institutions and the Path to the Modern Economy: Lessons from Medieval Trade, Cambridge University Press.

Jacobson, P., (2014); “Addiopizzo: The Grassroots Campaign Making Life Hell for the Sicilian Mafia,” Newsweek, September 17, 2014.

Ostrom, E., (2015); Governing the Commons: Evolution of Institutions for Collective Action, Cambridge University Press, Canto Classics reissue.

Superti, C., (2009); “Addiopizzo: Can a Label Defeat the Mafia?” Journal of International Policy Solutions, 11, Spring 2009 3-11.

Endnotes

[1] This list derives from studies and meta-analyses of many prisoners’ dilemmas of collective action: common resource pool problems (most notably Ostrom 2015), contract enforcement (for example Greif 2006, and Dixit 2004), and socio-biology (for example Dugatkin, 1999), to cite just a few.

[2] For more detailed arguments see Dixit (2018).

[3] See Bernstein (1992).

[4] A model with supporting evidence is in Dixit (2017).

[5] See Superti (2009) and Jacobson (2014).

[6] An OpEd offers a starter attempt to implement these ideas in India: Dixit and Mankar (2018).

 

 

Institutional and Organizational Analysis: Concepts and Applications

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By Eric Alston (University of Colorado Boulder), Lee Alston (Indiana University Bloomington), Bernardo Mueller (University of Brasilia), and Tomas Nonnenmacher (Allegheny College, Pennsylvania)

Today, the notion that “institutions matter” is broadly accepted.  Scholars have generated a rich literature on the causes and effects of institutions spanning from the micro to the macro level. The pioneering work of Buchanan, Coase, North, Ostrom, Williamson, and many others is the fertile soil in which the literature in Institutional and Organizational Analysis (IOA) has taken root and blossomed. There is a wealth of institutional scholarship that now spans disciplines, decades, and continents. Our 2018 book with Cambridge University Press, Institutional and Organizational Analysis: Concepts and Applications, expands on many of the major contributions in this area, organized within a framework that explains both the effects and determinants of institutions and norms.

Our book is centered on the insight that institutions and norms are fundamental determinants of economic and political development. Institutions are rules that recognized authorities create, and choose whether or not to enforce. Norms are long-standing patterns of behavior, shared by a subset of people in a society or organization. Institutions and norms play a role in all organizations, including governments, firms, churches, universities, gangs, and even families. In our book, we (1) present a set of concepts—for example, institutions, norms, property rights, and transaction costs—used in IOA that link institutions and norms to economic performance; (2) use the same set of concepts to better understand political organizations and performance; and (3) build a framework based on those concepts for understanding divergent developmental trajectories of nations around the world. In Parts I and II, we define the concepts needed to understand how economic activity is organized and how institutions and norms shape economic and political outcomes. In Part III, we add the comparatively recent work on beliefs and leadership to better understand the fundamental question of why there has not been convergence in economic and political performance across countries. In the following paragraphs, we summarize the three parts of our book in greater detail, which is intended as a useful reference for advanced students and scholars alike.

In Part I of the book, we link institutions to property rights, transaction costs, and economic performance. In Chapter 1, we examine how institutions and norms shape property rights. Property is a social construct; that is, property rights define our ability to use different aspects of an asset. In Chapter 2, we define transaction costs as the costs of “transfer, capture, and protection” of property rights. Transaction costs are a key determinant of organizational and contractual choice. In Chapter 3, we analyze how different types of transaction costs shape the structure of contracts and organizations. The price mechanism and hierarchies can be thought of as endpoints on a spectrum of contractual choices, and we provide a theoretical justification for and examples of different intermediary forms.

In Part II, we explain the determinants of institutions taking as fixed the basic constitutional rules and current economic performance. In the four chapters, we analyze the process through which groups and individuals lobby and government supplies laws and regulations. In Chapter 4, we address the role and impact of interest groups on government policy. Every policy is potentially redistributive, so firms and individuals organize to influence redistribution in their favor. In Chapter 5, we assess the roles of the legislature and the executive as the organizations in charge of creating and implementing legislation. In Chapter 6, we address the role of the bureaucracy and its impacts on the content, quality, and effectiveness of the outcomes of laws. In Chapter 7, we analyze how institutions can influence the structure and output of the judiciary. We also examine the impact that judiciaries have on institutions and norms.

Simple economics suggest that countries should have converged in terms of economic and political development. Moreover, scholars in the IOA have spilled a lot of ink in showing the socially beneficial institutions that accompany development. But despite an increasingly well-known institutional template, countries have not converged in terms of economic and political development and, in many cases, have outright declined. A number of explanations to this puzzle have emerged: (1) it is not in the interest of those in power to have economic and political development; (2) poorer countries have not converged because the volatility of their growth rates means such economies are as likely to shrink as grow; and (3) a change in fundamental core beliefs about how institutions affect outcomes is required to break out of the status quo. In Part III, we discuss the role of core beliefs and leadership in bringing about changes to constitutional-level institutions. Though we do not directly analyze culture or ideas as a determinant, we recognize their importance as background conditions that determine which belief changes take place. We stress leadership for its coordinative function within a dominant network that is negotiating how to respond to either an existing shock or a foreseeable crisis that could be attenuated or avoided, provided sufficient institutional change occurs.

Further, we identify fruitful avenues for research within each of our referential frames of institutional and organizational analysis, from the economic to the political to the constitutional. Our text provides useful background for the future areas of research we suggest by laying out many of the foundational contributions of the emerging discipline. It is our hope that the text will serve as a resource in helping to define the still emerging field of IOA. Our book is relevant for advanced undergraduates, as well as a valuable reference for graduate students and scholars. The analysis of the emergence and evolution of complex rule sets has proven to be one of the most illuminating areas of economic study over the course of the past century, and we accordingly describe how much more we think the field has to contribute.

Protection in Government Procurement Auctions

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By Matthew T. Cole (California Polytechnic State University), Ronald B. Davies (University College Dublin), and Todd Kaplan (University of Exeter Business School and University of Haifa)

Government procurement contracts are a large part of many economies, often accounting for 15-20% of GDP.[1] Given the significant size of these contracts and their public-sector nature, it is unsurprising that there is a long-standing tradition of protecting domestic bidders from foreign ones. A standard method of doing so has been to use a “price preference”, that is, awarding the contract to the lowest domestic bidder even if there are lower foreign bids, just so long as that domestic bid is not too much higher than the lowest foreign bid.  For example, under the European Community’s rules, contracts were awarded to a member firm so long as its bid was no more than 3% higher than the lowest non-member-bid.[2] Obviously, this is not the only method of discriminating against foreigners with tariffs being but one alternative. Despite this history, in step with the overall drive towards trade liberalization, efforts have been taken towards reducing the use of price preferences. Chief among these was the 1996 Government Procurement Agreement (GPA) which would have enforced non-discrimination in contract bidding among participating countries.[3] Importantly, this agreement which covers a subset of WTO members primarily addresses price preferences and not other discrimination mechanisms, with tariffs still being permitted as per other WTO regulations. Thus, there is a need to understand how different methods of protectionism in procurement contract auctions compare with one another. This is especially true in the current international climate where there appears to be a marked shift towards protectionism. Comparing these policies is the goal of our analysis.[4]

To do so, we modify a standard auction model in which two firms, one domestic and one foreign, are each endowed with a privately-known cost. Armed with this knowledge, the firms simultaneously submit expected profit-maximizing bids to the government under one of two policy settings. In the first, consistent with practice, we impose a price preference where the contract is awarded to the domestic firm so long as its bid is no more than a fixed percentage p higher than that of the foreign firm. The other is an ad valorem tariff t which is applied to the foreigner’s bid should it win. Note that this latter is equivalent to a tariff on the foreigner’s cost since there is a one-to-one mapping between winning bids and firm costs.

From the firms’ perspectives, there is an equivalence across the two policies, that is, for each price preference level p there is a tariff t = p that is equivalent both in terms of the probability of winning and expected profits. Intuitively, this happens because if the government replaces the price preference with a tariff of the same level, when the foreign firm increases its bid so that after-tariff profits are the same, this does not alter the bidding behaviour of the domestic firm, meaning that the probability of winning and expected after-tariff profits remain the same.

Turning to the government, we assume that it chooses its policy to maximize the expected sum of three things: the surplus generated from the contract (i.e. minimize the expected bid), expected tariff revenues (which may be costly to collect), and, given the inherently political nature of trade policy, the weighted profits of the domestic firm (where the weight represents the value of private profits relative to public revenues). When tariffs are costless to collect, the equivalence for firms holds for the government as well. This occurs because, even though a shift from a price preference p to a tariff of the same rate increases the expected cost of the contract (since the winning firm sets a higher bid), this increase is exactly offset by the rise in expected tariff revenue. In addition, with costless tariffs the government’s preferred policy is one that discriminates against foreign bidders, often to the detriment of global welfare (the sum of all players’ payoffs). Thus, under this condition, at its worst the GPA would have no impact on the level of protection between members in procurement contests. Further, if tariffs are constrained below the equivalence level under the WTO so that GPA signatories could not use their equivalent tariffs, the agreement would result in a more level playing field.

These results, however, assume that tariffs are costless to collect, something that runs counter to the empirical evidence.[5] When there are, for example, enforcement and administration costs associated with tariffs, switching from a price preference to the firm-equivalent tariff results in lower expected government welfare since the foreign firm’s bid goes up by more than the after-collection cost tariff revenue. Because of this, so long as expected tariff revenues are rising in the tariff, the government finds protection less attractive when using a tariff and, if forced to abandon the price preference, it would set it such that protection is smaller than under its preferred price preference. Thus, in this setting, even if the tariff is unconstrained by WTO regulations, one would expect the introduction of the GPA to be efficiency-improving.

Together, these results suggest that the GPA, in particular with binding limits on tariffs under preferential trade agreements, can be expected to have lowered protection levels in government procurement auctions and increase global welfare. This has important lessons for the current trade negotiation situation. First, with threats to exit various trade agreements rising rapidly, our findings indicate that if countries were to quit the GPA this would result in rising protectionism with consequent welfare losses. Second, even if the GPA remains intact, if political pressures lead to rising tariffs even under the oversight of the WTO, this may serve to roll back the gains achieved by the GPA.

References

Branco, F., (1994); “Favoring Domestic Firms in Procurement Contracts.” Journal of International Economics, 37, 65-80.

Cole, M.T., R.B. Davies, and T. Kaplan, (2017); “Protection in Government Procurement Auctions,” Journal of International Economics, 106:134-142.

Riezman, R., and J. Slemrod, (1987); “Tariffs and Collection Costs.” Review of World Economics, 123, 545-549.

World Trade Organization, (2013); “Government Procurement.” Retrieved from http://www.wto.org/english/tratop_e/gproc_e/gproc_e.htm on July 31 2013.

Endnotes

[1] World Trade Organization (2013).

[2] Branco (1994).

[3] See WTO (2013) for details.

[4] For full analysis, see Cole, Davies and Kaplan (2017).

[5] See Riezman and Slemrod (1987).

Special Issue “New Institutional Economics”

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Special Issue Information

Dear Colleagues,

It has been twenty years since Ronald Coase claimed, in the proceedings of the Annual Meeting of the American Economic Association, that “When the majority of economists have changed, mainstream economists will acknowledge the importance of examining the economic system in the way [of new institutional economics] and will claim that they knew it all along.” Twenty years later, new institutional economics has nearly become a household name among “mainstream economists” and enriched economics by taking the institutional context of economic transactions into account.

To take stock of the progress of the field, Economies is inviting contributions for a Special Issue devoted to new institutional economics.

Submissions relating to all the facets of the field are welcome. Topics can cover, but are not limited to, the causes and determinants of democratic transitions, institutional quality, culture, religion, aid, international trade and development, and war. Contributions can be theoretical or empirical and use contemporary or historical data. Critical surveys are also welcome.

Prof. Dr. Pierre-Guillaume Méon
Guest Editor

Manuscript Submission Information

Manuscripts should be submitted online at www.mdpi.com by registering and logging in to this website. Once you are registered, click here to go to the submission form. Manuscripts can be submitted until the deadline. All papers will be peer-reviewed. Accepted papers will be published continuously in the journal (as soon as accepted) and will be listed together on the special issue website. Research articles, review articles as well as short communications are invited. For planned papers, a title and short abstract (about 100 words) can be sent to the Editorial Office for announcement on this website.

Submitted manuscripts should not have been published previously, nor be under consideration for publication elsewhere (except conference proceedings papers). All manuscripts are thoroughly refereed through a single-blind peer-review process. A guide for authors and other relevant information for submission of manuscripts is available on the Instructions for Authors page. Economies is an international peer-reviewed open access quarterly journal published by MDPI.

Please visit the Instructions for Authors page before submitting a manuscript. The Article Processing Charge (APC) is waived for well-prepared manuscripts submitted to this issue. Submitted papers should be well formatted and use good English. Authors may use MDPI’s English editing service prior to publication or during author revisions.

Published Papers

This special issue is now open for submission.

Export Competitiveness of Developing Countries and US Trade Policy

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By Shushanik Hakobyan[1] (International Monetary Fund)

With rising US trade protectionism against its major trading partners, the Generalized System of Preferences or GSP, a long-running scheme of tariff exemptions meant to aid exporters in developing countries, may get less attention. While GSP imports account for about one percent of total US imports, they account for about ten percent of all imports from GSP beneficiaries with considerable heterogeneity across countries.[2] Since the early 1970s, the GSP has given a boost to these exporters by granting their products duty-free access to the US market thereby aiding the efforts to expand their industrial and exporting capacity. But as with any policy, the devil is in the details. Despite the benefits, uptake has been low due to a number of reasons, including a low margin of preference granted by GSP, uncertainty about the permanence of the GSP program, and the statutory caps on benefits designed to prevent “abuse” by successful exporters.[3] My research focuses on the latter and explores whether these caps are well-targeted and serve their designated purpose.[4]

One of the features of the US GSP, the so-called Competitive Needs Limits, or CNLs, act as caps on benefits by excluding exporters exceeding CNL thresholds. There are two criteria to identify country-product pairs that have exceeded CNLs: (1) imports exceeding a certain value threshold in a calendar year, set at $180 million in 2017, and increasing by $5 million every year; (2) import share of a country in a given product exceeding the percentage threshold set at 50 percent. Meeting either criteria triggers an automatic exclusion of a country-product pair from GSP in the following year. The range of imports that exceed these thresholds varies greatly in terms of value. For example, the eligibility of Indian exporters of gold necklaces and neck chains was revoked in 2008, following their exports reaching $266 million in the previous calendar year (the value threshold in 2007 was set at $130 million). Likewise, the Argentine exporters of green olives lost their GSP eligibility in 2008 after accounting for 66 percent of total imports of green olives into the US in 2007. It is worth noting that Argentina had not exported green olives in the previous five years prior to 2007.

There are three ways to avoid losing the GSP benefits due to the CNL. First, if total US imports of a given product are trivial, at most $23.5 million in 2017 (set to increase by $0.5 million every year), a de minimis waiver could be applicable. Second, the percentage threshold may be waived if a directly competitive product was not produced in the US on January 1, 1995 (504(d) waiver). Lastly, country-product pairs exceeding the value or percentage CNL may petition for a more “permanent” CNL waiver.

To evaluate the impact of these caps on exporters, I examine the universe of all country-product pairs that have been excluded for more than two years from GSP over the period of 1997-2010. There have been 202 country-product pairs that met the CNL criteria in this period and were excluded from the GSP, accounting for $7 billion in imports (in the pre-exclusion year) or about 31 percent of US imports claiming GSP on average over this period. I estimate country-product level regressions of the value and share of imports on a set of binary variables indicating the first, second and third year of exclusion.

I find that the CNL exclusions are associated with a continuous decline in exports and import shares for up to three years after the exclusion, leading to a 75 percent drop by the third year of exclusion relative to the pre-exclusion average. Similarly, import shares drop by 42 percentage points from an average of 63 percent prior to the exclusion. This drop is predominantly driven by exporters who meet the percentage threshold with lower valued exports. These results are robust to employing volume data instead of values. Furthermore, the effect is larger for products facing higher MFN tariff rates. By the third year of exclusion, the value of imports and import shares of exporters eligible for a de minimis waiver drop by 50 and 75 percent, respectively, relative to pre-exclusion averages. In contrast, the impact of CNLs on the largest country-product pairs that exceeded the value threshold is negligible.

A related question of interest is the potential impact of CNLs on imports from other GSP beneficiary countries. If CNL-affected countries are unable to continue exporting to the US, who fills the void — other GSP countries or non-GSP countries? I find that import shares rise considerably more for non-GSP countries. By the third year of exclusion, the share of imports from other GSP eligible countries increases by 7 percentage points from a pre-exclusion average of 7 percent, whereas the share of imports from non-GSP countries rises by 29 percentage points (pre-exclusion average share is 25 percent).

Arguably, CNLs do not serve their intended purpose of identifying exporters who no longer need the preferential market access and allowing other GSP beneficiary countries benefit more from the program. Instead, CNLs tend to target small exporters, forcing them to stop exporting to the U.S. altogether, and mostly benefit non-GSP exporters.

These findings call for tweaks to the design of the program. Two simple changes can be made to boost the utilization of the program. First, since percentage CNL fails to identify successful exporters, a more holistic approach that takes into account both the value of imports and market share is needed to accurately detect such exporters. Second, the analysis of exports over a longer period (instead of the statutory one year) could go in hand with the previous suggestion by capturing the export dynamics of given products. These simple changes would ensure a lasting market access for the countries whom the GSP scheme is intended to help.

References

Blanchard, E., and S. Hakobyan, (2015); “The U.S. Generalized System of Preferences in Principle and Practice,” The World Economy 38(3).

Hakobyan, S., (2015); “Accounting for Underutilization of Trade Preference Programs: U.S. Generalized System of Preferences,” Canadian Journal of Economics 48(2), 2015.

Hakobyan, S., (2017a); “Export Competitiveness of Developing Countries and U.S. Trade Policy,” The World Economy 40(7).

Hakobyan, S., (2017b); “GSP Expiration and Declining Exports from Developing Countries,” Working Paper, 2017.

Ornelas, E., (2016); “Special and Differential Treatment for Developing Countries,” in Handbook of Commercial Policy, Kyle Bagwell and Robert W. Staiger (eds.), Vol. 1B, Amsterdam, North-Holland: Elsevier.

Endnotes

[1] The views expressed in this column are those of the author and should not be attributed to the IMF, its Executive Board, its management, or its member country governments.

[2] See Ornelas (2016) for a general introduction to GSP, an aspect of special and differential treatment for developing countries under the World Trade Organization.

[3] See Blanchard and Hakobyan (2015), Hakobyan (2015, 2017b).

[4] See Hakobyan (2017a).

Summary of the 5th InsTED Workshop at Syracuse University

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

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

Global Value Chains: Their Determinants and Implications

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

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

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

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

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

Trade Integration and Income Distribution

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

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

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

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

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

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

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

Trade and Resource Reallocation Effects of Trade Integration and Institutional Reform

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

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

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

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

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

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

Institutional Constraints on Trade Policy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Behzadan, N., and R. Chisik “The Paradox of Transfers: Distribution and the Dutch
Disease.”

Brunel, C., and T. Zylkin “Do Cross-Border Patents Promote Trade?”

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

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

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

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

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

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

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

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

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

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

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

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

Firm Productivity Differences from Factor Markets: New Evidence from China

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By Wenya Cheng (University of Glasgow) and John Morrow (Birkbeck, University of London)

Although firms may face radically different production conditions, this dimension of firm heterogeneity is often overlooked. A number of studies document large and persistent differences in productivity across both countries and firms.[1] However, these differences remain largely ‘some sort of measure of our ignorance’. It’s therefore worth inquiring to what extent the supply characteristics of regional input markets help explain such systematic productivity dispersion across firms, differences which remain a ‘black box’.[2] It would be surprising if disparate factor markets result in similar outcomes, when clearly the prices and quality of inputs available vary considerably, as when markets are thin, incomplete, distorted or highly heterogeneous: in short, in most developing country markets. Recent work has indicated imperfect factor mobility has sizable economic effects and that developing country distortions are large.[3] Our recent work models firm adaptation to such variation in a general equilibrium framework which microfounds these distortions and heterogeneity.[4] The structural equations of the model are simple to estimate and the estimation results quantify the importance of local factor markets for firm input use, productivity and welfare.

To better understand the environments that firms operate in, we model regional inputs markets with differing distributions of worker types, wages and regional input quality. Firms can hire different types of labor (e.g. education groups or occupations) and within each type, worker quality varies and incurs search costs. As the ease of finding higher quality workers increases with their regional supply, firm hiring depends on the joint distribution of worker types and wages. Our estimates indeed confirm that contrary to standard models with perfectly competitive labor markets, firm hiring responds to not only wages, but also the availability of worker types. Since each firm’s optimal workforce varies by industry and region, the comparative advantage of regions varies with its labor market characteristics. Since industries also differ in factor intensity, local capital and materials costs also influence the comparative advantage of a region. As the model also explicitly models entry, firms locate in proportion to the cost advantages available.

To quantify real world supply conditions, we use the model to derive estimating equations which fix: 1) hiring by wage and worker type distributions, 2) substitution into non-labor inputs and 3) firm location in response to local factor markets. The estimation strategy combines manufacturing and population census data for China in the mid-2000s, a setting which exhibits substantial local variation (see Figures 1, 2 a,b).

Figure 1 Chinese Prefectures Average Monthly Income of Employees (2005)

Figure 2 (a) % of Labor Force with less than or equal to Junior High School

Figure 2 (b) % of Labor Force with greater than or equal to Junior College

By revealing how firm demand for skills varies with local conditions, the model quantifies the unit costs for labor across China. The estimates based on within-firm hiring patterns imply interquartile differences in effective labor costs across prefectures which range from 30 to 80 percent (see Figure 3). Taking into account industry level production estimates of capital, labor and materials expenditure shares, these labor cost differences imply productivity differences of 3 to 12 percent. This helps explain the productivity difference ‘black box’ by reducing the variance of productivity residuals in every industry compared to a production function using counts of worker types or the wage bill. Extending this approach we also find that capital and materials frictions combined explain a similar range of productivity differences.

Figure 3: Geographic Dispersion of Unit Labor Costs: General Machines

The model has welfare implications for microeconomic changes in labor markets that shift regional comparative advantage and thereby the distribution of industry activity in general equilibrium. For instance, if the highly heterogenous distribution of workers and wages is due to regional frictions (e.g. the hukou system in China) then homogenizing worker distributions and wages across labor markets helps capture what the removal of these frictions might imply. In theory, this homogenization could lead to gains from variety being more evenly sourced across regions but could also lessen regional comparative advantages and gains from specialization. Ultimately these competing forces must be resolved quantitatively. Using Input-Output and population data, the model implies that homogenizing across factor markets would, on net, increase real incomes by 1.33 percent.

The importance of local factor markets for understanding firm behavior suggests new dimensions for policy analysis. For instance, regions with labor markets which generate lower unit labor costs for an industry attract higher levels industry activity. As unit labor costs depend on the distribution of wages and worker types that represent substitution options, this yields a deeper view of how educational policy or flows of different worker types impact firms. For this reason, work evaluating wage determination could be enriched by taking this approach. Taken as a whole, the results show that policy changes which influence the composition of regional labor markets will likely have sizeable effects on firm productivity and location. Finally, the substantial differences within industry suggest that at the regional level, inherent comparative advantages exist which policymakers might leverage.

In fact, relatively little is known about the dynamic relationships between labor markets and firm behavior, and this paper provides both a general equilibrium theory and structural estimation strategy to evaluate these linkages.[5] Having seen that cost and productivity differences inherent in local factor markets are potentially large, our approach could be of use in evaluating trade offs between regional policies or ongoing trends across regions. Further work could leverage or extend the approach of combining firm, census and geographic data to better understand the role of local factor markets on firm behavior.

References

Cheng, W. and J. Morrow, (2018); “Firm Productivity Differences from Factor Markets.” Journal of Industrial Economics, 66(1): 126–171.

Hsieh, C. T. and P. J. Klenow, (2009); “Misallocation and Manufacturing TFP in China and India.” Quarterly Journal of Economics, 124(4): 1403–1448.

Melitz, M.J. and S.J. Redding, (2014); “Heterogeneous Firms and Trade.” Handbook of International Economics, Vol. 4: 1–54.

Ottaviano, G., and G. Peri, (2013) “New Frontiers of Immigration Research: Cities and Firms.” Journal of Regional Science, 53(1): 1–7.

Syverson, C., (2011); “What Determines Productivity?” Journal of Economic Literature, 49(2): 326–365.

Topalova, P., (2010); “Factor Immobility and Regional Impacts of Trade Liberalization: Evidence on Poverty from India.” American Economic Journal: Applied Economics, 2(4): 1–41.

Endnotes

[1] See Syverson (2011).

[2] See Melitz and Redding (2014).

[3] See Topalova (2010) and Hsieh and Klenow (2009).

[4] See Cheng and Morrow (2018).

[5] See Ottaviano and Peri (2013).