Financial liberalization, structural change, and real exchange rate appreciations

The last twenty years have witnessed periods of sustained appreciations of the real exchange rate in emerging economies. The case of Mexico between 1988 and 2002 is representative of several episodes in Latin America and Central and Eastern Europe in which countries opening to capital flows experienced large appreciations accompanied by a significant reallocation of workers towards the non-tradable sector. We account for these facts using a two sector dynamic general equilibrium model of a small open economy with frictions to labor reallocation and two driving forces: (i) A decline in the cost of borrowing in foreign markets, and (ii) differential productivity growth across sectors. These two mechanisms account together for 60% of the decline in the domestic relative price of tradables in Mexico and for a large fraction of the observed reallocation of labor across sectors. The decline in the interest rate faced by Mexico in international markets is quantitatively the most important channel. Our results are robust to the inclusion of terms of trade into the model.     

Terms of trade and exchange rate regimes in developing countries

Since Friedman [Essays in Positive Economics, University of Chicago Press, Chicago (1953) 157-203] an advantage often attributed to flexible exchange rate regimes over fixed regimes is their ability to insulate more effectively the economy against real shocks. I use a post-Bretton Woods sample (1973-96) of 75 developing countries to assess whether the responses of real GDP, real exchange rates, and prices to terms-of-trade shocks differ systematically across exchange rate regimes. I find that responses are significantly different across regimes in a way that supports Friedman’s hypothesis. The paper also examines the importance of terms-of-trade shocks in explaining the overall variance of output and prices in developing countries.     

Volatility due to offshoring: Theory and evidence

Existing models of offshoring are not equipped to explain how global production sharing affects the volatility of economic activity. This paper develops a trade model that can account for why offshoring industries in low wage countries such as Mexico experience fluctuations in employment that are twice as large as in high wage countries such as the United States. We argue that a key to explaining this outcome is that the extensive margin of offshoring responds endogenously to shocks in demand and transmits those shocks across borders in an amplified manner. Empirical evidence supports the claim that the extensive margin of offshoring is an active margin of adjustment, and quantitative simulation experiments show that the degree of movement of this margin in the data is sufficient to explain relative employment volatility in Mexico and the U.S.     

The specific factors continuum model, with implications for globalization and income risk

This paper embeds the specific factors model in the goods continuum approach of Dornbusch et al. (1977, 1980) and applies it to analyze the effect of globalization on income risk. Globalization amplifies sector specific income risk induced by idiosyncratic sectoral technology shocks, but tends to reduce income risk to both mobile and immobile factors induced by aggregate technology shocks that differ by country. Aggregate risk bears most heavily on the poorest specific factors.     

Exchange rate exposure: A nonparametric approach

The typical conclusion reached when researchers examine exchange rate exposure is that only a few firms are exposed. This finding is puzzling since institutional knowledge and theory suggests a larger effect. In this paper, we compare results obtained using a linear approach with those from nonlinear and nonparametric models. Among firms that don't have a linear exposure, we find that a considerable proportion of these are exposed when nonlinear or nonparametric models are used. This exposure is most striking when a nonparametric model is used. We also find that firms' hedging activities decrease linear exposure but don't affect nonparametric exposure.     

Banking crises and exchange rate regimes: is there a link?

This paper investigates the linkages between banking crises and exchange rate regimes, using a comprehensive cross-country dataset for the last two decades. The paper examines whether the choice of exchange rate regime affects the likelihood, cost, and duration of banking crises. Empirical results seem to indicate that adopting a fixed exchange rate diminishes the likelihood of banking crises among developing countries. However, once crises occur, the real costs associated with them appear to be larger in countries with fixed exchange rates. The duration of crises does not seem to be robustly affected by the exchange rate policy.     

Fixed exchange rates and trade

A classic argument for a fixed exchange rate is its promotion of trade. Empirical support for this, however, is mixed. While one branch of research consistently shows a small negative effect of exchange rate volatility on trade, another, more recent, branch presents evidence of a large positive impact of currency unions on trade. This paper helps resolve this disconnect. Our results, which use a new data-based classification of fixed exchange rate regimes, show a large, significant effect of a fixed exchange rate on bilateral trade between a base country and a country that pegs to it. These results suggest an economically relevant role for exchange rate regimes in trade determination since a significant amount of world trade is conducted between countries with fixed exchange rates.     

Gravity, trade integration, and heterogeneity across industries

We derive a micro-founded measure of bilateral trade integration that is consistent with a broad range of leading gravity models. This measure accounts for cross-industry heterogeneity by incorporating substitution elasticities estimated at the industry level. We then use it to provide a theory-based ranking of trade integration across manufacturing industries in European Union countries. In addition, we explore the determinants of trade integration, finding that substantial Technical Barriers to Trade in certain industries as well as high transportation costs associated with heavy-weight goods are the most notable trade barriers.     

Power laws in firm size and openness to trade: Measurement and implications

Existing estimates of power laws in firm size typically ignore the impact of international trade. Using a simple theoretical framework, we show that international trade systematically affects the distribution of firm size: the power law exponent among exporting firms should be strictly lower in absolute value than the power law exponent among non-exporting firms. We use a dataset of French firms to demonstrate that this prediction is strongly supported by the data, both for the economy as a whole and at the industry level. Furthermore, the differences between power law coefficients for exporters and non-exporters are larger in sectors that are more open to trade. While estimates of power law exponents have been used to pin down parameters in theoretical and quantitative models, our analysis implies that the existing estimates are systematically lower than the true values. We propose two simple ways of estimating power law parameters that take explicit account of exporting behavior.     

Transportation, freight rates, and economic geography

We investigate the role of competitive transport markets in shaping the location of economic activity and the pattern of trade. In our model, carriers supply transport services for shipping manufactured goods, and freight rates are set to clear transport markets. Each carrier must commit to the maximum capacity for a round-trip and thus faces a logistics problem as there are opportunity costs of returning empty. These costs increase the freight rates charged to firms located in regions that are net exporters of manufactured goods. Since demand for transport services depends on the spatial distribution of economic activity, the concentration of production in one region raises freight rates to serve foreign markets from there, thus working against specialization and the agglomeration of firms. Consequently, a more even spatial distribution of firms and production prevails at equilibrium when freight rates are endogenously determined than when they are assumed to be exogenous as in the literature.     

A state-dependent model of intermediate goods pricing

Recent analyses of transaction-level data sets have generated new stylized facts on price setting and greatly influenced the empirical open- and closed-economy macroeconomics literatures. This work has uncovered marked heterogeneity in price stickiness, demonstrated that even non-zero price changes do not fully “pass through” exchange rate shocks, and offered evidence of synchronization in the timing of price changes. Further, intrafirm prices have been shown to differ from arm's length prices in each of these characteristics. This paper develops a state-dependent model of price setting by strategic intermediate goods producers that anticipate and respond to their competitors' actions. The model, which allows for both arm's length and intrafirm transactions, is able to generate all of these empirical pricing patterns.     

Currency crises with the threat of an interest rate defence

While virtually all currency crisis models recognise that the decision to abandon a peg depends on how tenaciously policy makers defend it, this is seldom modelled explicitly. We add the threat of an interest rate defence to the global game model of Morris and Shin (American Economic Review 88, 1998). With an endogenous defence, actions of speculators may become strategic substitutes instead of the usual complements. Nevertheless, our generalised model remains tractable and has a unique threshold equilibrium. It provides additional insights. For instance, the threat of an interest rate defence makes speculation riskier and this may be sufficient to keep speculators out when fundamentals are still relatively strong.     

Domestic productivity and variety gains from trade

We show theoretically and confirm empirically that domestic productivity has a significant impact on the demand for foreign varieties under the assumption that domestic and foreign varieties are imperfect substitutes. In particular, the demand for imported varieties is more elastic for countries with comparative advantage. For an average good facing a median trade barrier, doubling the importer–exporter relative export performance decreases the number of imported varieties by 17%. Our findings suggest that the variety gains estimates could be significantly biased if we ignore the substitutability between imported and domestic varieties.     

Estimating vertical spillovers from FDI: Why results vary and what the true effect is

In the last decade, more than 100 researchers have examined productivity spillovers from foreign affiliates to local firms in upstream or downstream sectors. Yet results vary broadly across methods and countries. To examine these vertical spillovers in a systematic way, we collected 3626 estimates of spillovers and reviewed the literature quantitatively. Our meta-analysis indicates that model misspecifications reduce the reported estimates and journals select relatively large estimates for publication. No selection, however, was found for working papers. Taking these biases into consideration, the average spillover to suppliers is economically significant, whereas the spillover to buyers is statistically significant but small. Greater spillovers are received by countries that have underdeveloped financial systems and are open to international trade. Greater spillovers are generated by investors who come from distant countries and have only a slight technological edge over local firms.     

Competition for firms in an oligopolistic industry: The impact of economic integration

We set up a model of generalised oligopoly where two countries of different size compete for an exogenous, but variable, number of identical firms. The model combines a desire by national governments to attract internationally mobile firms with the existence of location rents that arise even in a symmetric equilibrium where firms are dispersed. As economic integration proceeds, equilibrium taxes initially decline, but then rise again as trade costs fall even further. A range of trade costs is identified where economic integration raises the welfare of the small country, but lowers welfare in the large country.     

Foreign subsidization and excess capacity

The U.S. steel industry has long held that foreign subsidization and excess capacity has led to its long-run demise, yet no one has formally examined this hypothesis. In this paper, we incorporate foreign subsidization considerations into a model based on Staiger and Wolak's (1992) cyclical dumping framework and illustrate testable implications of both cyclical excess capacity and structural excess capacity stemming from foreign subsidization. We then use detailed product- and foreign country-level data on steel exports to the U.S. market to estimate these excess capacity effects. While the full sample results provide evidence of both cyclical and structural excess capacity effects for exports to the U.S. market, these effects are confined to such a narrow range of country–product combinations that it is unlikely that such effects were a significant factor in the fortunes of U.S. steel firms over the past decades.     

Plant-level responses to antidumping duties: Evidence from U.S. manufacturers

This paper describes the effects of a temporary increase in tariffs on the performance and behavior of U.S. manufacturers. Using a dataset that includes the full population of U.S. manufacturing plants, I show that an apparent positive correlation between antidumping duties and traditional revenue productivity is likely misleading. For the subset of plants reporting quantity-based output data, increases in prices and markups artificially inflate the effect of antidumping duties on revenue productivity, while physical productivity actually falls. Moreover, antidumping duties allow low-productivity plants to continue producing protected products, slowing the reallocation of resources from less productive to more productive uses.     

Location decision of heterogeneous multinational firms

We examine how multinational firms with heterogeneous total factor productivity (TFP) self-select into different host countries. Both aggregate- and firm-level estimates suggest that more productive French firms are more likely than their less efficient competitors to invest in relatively tough host countries. Countries with a smaller market potential, higher fixed costs of investment or lower import tariffs tend to have higher cutoff productivities and attract a greater proportion of productive multinationals. This self-selection mechanism remains largely robust when we control for unobserved firm and country heterogeneity and address potential TFP endogeneity.     

International capital flows

The surge in international asset trade since the early 1990s has lead to renewed interest in models with international portfolio choice. We develop the implications of portfolio choice for both gross and net international capital flows in the context of a simple two-country dynamic stochastic general equilibrium (DSGE) model. We focus on the time-variation in portfolio allocation following shocks, and resulting capital flows. Endogenous time-variation in expected returns and risk, which are the key determinants of portfolio choice, affect capital flows in often subtle ways. The model is consistent with a broad range of empirical evidence. An additional contribution of the paper is to overcome the technical difficulty of solving DSGE models with portfolio choice by developing a broadly applicable solution method.