Category Archives: International Trade

Economic Determinants of Multilateral Environmental Agreements

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

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

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

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

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

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

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

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

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

References

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

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

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

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

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

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

Endnotes

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

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

[3] See Barrett (2002).

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

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

Optimal Trade Policy with Trade Imbalances

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

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

Method

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

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

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

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

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

Results

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

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

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

Figure 1 Panel A

Figure 1 Panel B

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

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

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

Remaining Questions

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

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

Conclusion

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

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

References

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

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

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

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

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

Endnotes

[1] Beshkar and Shourideh (2020).

[2] See Ossa (2016).

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

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

 

 

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

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

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

There now follows a summary of all the papers presented at the workshop, organized under the four topic headings above.  A bibliography, together with links to papers where available, is provided at the end.  Please note that for brevity the summary mentions presenters’ names but not those of their co-authors.  This information is contained in the bibliography.

Factor Allocation, Productivity, and Economic Development

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

Income Shocks, Distortions and Development

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

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

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

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

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

Conflict, Misallocation, and Development Failure

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

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

Infrastructure, Uncertainty, and Economic Development

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

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

Trade Policies, Externalities, and Agreements

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

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

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

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

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

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

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

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

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

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

WTO Institutional Design

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

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

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

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

International Trade and Economic Development

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

Trade Distortions and Economic Development

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

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

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

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

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

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

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

Labor Market Distortions, Trade and Development

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

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

Political Institutions and Economic Development

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

Democracy and Economic Development

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Markus Eberhardt “Democracy Does Cause Growth: Comment“

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

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

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

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

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

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

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

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

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

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

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

Lena Sheveleva “Minimal Model of Multi-product Firms“

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

 

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

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

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

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

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

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

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

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

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

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

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

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

References

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

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

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

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

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

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

Endnotes

[1] Rodrigue and Tan (2019).

[2] See Kugler and Verhoogen (2012).

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

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

Economic Shocks and Crime: Evidence from the Brazilian Trade Liberalization

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

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

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

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

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

Figure 1 Effect of Trade liberalization on Regional Homicide Rates

 

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

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

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

References

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

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

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

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

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

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

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

Endnotes

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

[2] Mustard (2010).

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

[4] UNODC (2013).

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

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

The Impact of TRIPS and Compulsory Licensing on Developing Country Markets

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

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

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

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

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

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

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

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

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

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

References

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

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

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

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

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

Endnotes

[1] See Golderg (2010).

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

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

[4] See Bond and Saggi (2018).

 

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).

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.

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).

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).