Trade policy under firm-level heterogeneity in a small economy

We explore the effect of trade policy on productivity and welfare in the now standard model of firm-level heterogeneity and product differentiation with monopolistic competition. To obtain sharp results, we restrict attention to an economy that takes as given the price of imports and the demand schedules for its exports (a “small economy”). We first establish that welfare can be decomposed into four terms: productivity, terms of trade, variety and curvature, where the last is a term that captures heterogeneity across varieties. We then show how a consumption subsidy, an export tax, or an import tariff allows our small economy to deal with two distortions that we identify and thereby reach its first-best allocation. We also show that an export subsidy generates an increase in productivity, but given the negative joint effect on the other three terms (terms of trade, variety, and curvature), welfare falls. In contrast, an import tariff improves welfare in spite of the fact that productivity falls.     

Trade policy, cross-border externalities and lobbies: do linked agreements enforce more cooperative outcomes?

We analyze whether linking international cooperation in trade policy to environmental policy (or other issues with nonpecuniary externalities) promotes more cooperation in both policies, or whether cooperation in one is strengthened at the expense of the other. In the context of self-enforcing agreements, we show that if the policies are independent in the government's objective function, then linkage promotes cooperation in one policy at the expense of the policy that is easier to enforce under no-linkage. However, if the linked policies are not independent and if these policies are strategic complements, then linkage can sustain more cooperation in both issues than no-linkage. The policies are strategic complements only if (i) the production externality has cross-border effects; (ii) the weight on the externality cost is high; (iii) import competing lobbies are not “powerful”.     

Trade policy of a free trade agreement in the presence of foreign lobbying

This paper studies the effect of foreign lobbies on trade policy of a country which is a member of a Free Trade Agreement (FTA). It uses a monopolistically competitive political economy model in which the government determines external tariffs endogenously. The effect of foreign lobbying under the FTA is examined empirically using Canadian industry-level trade data that allow differentiating of lobby groups by the country of origin. The analysis suggests that the presence of foreign lobbying has a significant effect on the domestic trade policy. The heterogeneity of foreign lobbies is also important: the presence of an organized lobbying group in an FTA partner country tends to raise trade barriers while an organized lobbying group of exporters from outside of the FTA is associated with less protection.     

Trade patterns and export pricing under non-CES preferences

We develop a two-factor, two-sector trade model of monopolistic competition with variable elasticity of substitution. Firms' profits and sizes may increase or decrease with market integration depending on the degree of asymmetry between countries. The country in which capital is relatively abundant is a net exporter of the manufactured good, although both firm sizes and profits are lower in this country than in the country where capital is relatively scarce. The pricing policy adopted by firms depends neither on capital endowment nor country asymmetry. It is determined by the nature of preferences: when demand elasticity increases (decreases) with consumption, firms practice dumping (reverse-dumping).     

Exclusive dealing and common agency in international markets

This paper investigates the contractual choice between exclusive dealing and common agency in a simple international oligopoly model where products are sold through intermediaries. We find that when trade barriers are high, domestic firms tend to adopt exclusive dealing contracts whereas trade liberalization may lead firms to choose common agency. Social welfare can be raised be prohibiting exclusive dealing (common agency) when trade barriers are high (low) and products are close substitutes.     

Rivalry in uncertain export markets: commitment versus flexibility

This paper examines optimal trade policy in a two-period oligopoly model, with a home and a foreign firm choosing capital and output. Demand uncertainty, resolved in period two, gives rise to a trade-off between strategic commitment and flexibility in the firms’ investment decisions. Firms’ investment timing is endogenous and can be manipulated by the home government, which sets a subsidy before firms decide when to invest. We show that when the government wishes to manipulate investment timing, it will choose its policy to deter investment commitment by the home or the foreign firm.     

Cross-border mergers and market concentration in a vertically related industry: theory and evidence

We present a tractable model of oligopoly to identify the linkages between local competition and cross-border mergers in a vertically related industry. We show that the incentives for cross-border mergers rise with vertical integration in an industry when the premerger concentration in that industry is sufficiently high relative to the concentration in the same industry in a foreign country. We also show that the incentives for a merger between a foreign firm and a vertically integrated home firm will be higher than that for a merger between a foreign firm and a disintegrated home firm, when the premerger concentration at home is low relative to the premerger concentration in the foreign country. We then analyze a firm-level panel of 90,614 M&A observations, between 1990 and 2012, from 86 countries. Logistic regressions confirm that market concentration is an important determinant of cross-border M&A. Our results support the conjectures of our theoretical model and are consistent with recent empirical findings and theoretical predictions.     

Trade policy in a “super size me” world

When a foreign monopolist sets a single market clearing price for its product, the sign of the optimal tariff is determined by the extent of pass through (also known as the terms of trade effect). However, when a foreign monopolist employs a second degree price discrimination mechanism in the domestic market the calculus of welfare maximization is very different. While there are still terms of trade effects from the imposition of a tariff, the existence of such effects are neither necessary nor sufficient to determine the sign of the optimal tariff. Instead the distribution of valuations within the population is the key determinant of the nature of policy intervention. This result differs significantly from the uniform price case and is driven by the incentive compatibility constraint which places the distribution of types at the center of the analysis. If there is a relatively large fraction of high valuation types in the population, then domestic information rents may be increased by subsidizing imports thereby increasing the consumption of the low valuation types and moving the incentive constraint in favor of the high valuation types. However, if the share of high types in the population is relatively small then the increase in information rents will also be small but the fiscal implications of a subsidy will be large. Consequently, the optimal policy will be to impose a trade tax.     

Trade and industrial location with heterogeneous labor

It is shown in the context of a new economic geography model that when labor is heterogeneous trade liberalization may lead to industrial agglomeration and inter-regional trade. Labor heterogeneity gives local monopsony power to firms but also introduces variations in the quality of the job match. Matches are likely to be better when there are more firms and workers in the local market, giving rise to an agglomeration force which can offset the forces against, trade costs and the erosion of monopsony power. A robust agglomeration equilibrium is derived analytically and its properties illustrated with numerical simulations.     

Beyond the home market effect: Market size and specialization in a multi-country world

The standard two-country model of international trade with monopolistic competition predicts a more-than-proportional relationship between a country′s share of world production of a good and its share of world demand for that same good, a result known as the ‘home market effect’. We first show that this prediction does not generally carry through to the multi-country case, as production patterns are crucially affected by third country effects. We then derive an alternative prediction that holds whatever the number of countries considered. This new prediction takes into account important features of the real world such as comparative advantage due to cross-country technological differences and lack of factor price equalization.     

An empirical investigation of the pollution haven effect with strategic environment and trade policy

Using a new dataset on the stringency and enforcement of environmental policy, this study is the first to find robust confirmation of a pollution haven effect in a cross-country context by accounting for strategically determined environment, trade, and intellectual property right (IPR) policies. A simple game theoretic approach to policy determination is described which suggests an identification strategy based on other country characteristics. It is found that for the top 20th percentile of countries in terms of growth in U.S multinational affiliate value added, as much as 8.6% of that growth between 1999 and 2003 can be attributed to declining relative stringency and enforcement of environmental policy. The results are robust to a number of identification tests, weak IV tests, and third country spatial effects. Further, evidence is found that relatively ‘footloose’ industries are more likely to be affected by environmental policy than more traditionally ‘dirty’ industries and enforcement of environmental policies tends to be a more important deterrent than the stringency of the policy set.     

The effect of WTO on the extensive and the intensive margins of trade

We use 6-digit bilateral trade data to document the effect of WTO/GATT membership on the extensive and intensive product margins of trade. We construct gravity equations for the two product margins motivated by Chaney (2008). The empirical results show that standard gravity variables provide good explanatory power for bilateral trade on both margins. Importantly, we show that the impact of the WTO is concentrated almost exclusively on the extensive product margin of trade, i.e. trade in goods that were not previously traded. In our preferred specification, WTO membership increases the extensive margin of exports by 25%. At the same time, WTO membership has a negative impact on the intensive margin. Based on novel comparative statics results about how fixed and variable trade costs impact the product margins of trade, our results suggest that WTO membership works by reducing primarily the fixed rather than the variable costs of trade.     

The need for international policy coordination: what's old, what's new, what's yet to come?

The first generation of policy coordination models was introduced some 25 years ago; it provided a rationale for policy coordination, but the gains from coordination were generally thought to be small. Now, a new generation of policy coordination models is emerging, incorporating monopolistic competition and nominal inertia. Here, we examine macroeconomic interdependence and the scope for policy coordination in a tractable second generation model with two countries and multiple sectors. Initial calibration of the model suggests that second generation models may have more scope for policy coordination than did the first.     

Intraindustry trade and the skill premium: Theory and evidence

We explore theoretically and empirically the relationship between intraindustry trade and the skill premium. Our model features a Chamberlinian-type mechanism of income distribution based on quasi-homothetic consumer preferences, non-homothetic production, and factor-biased scale economies at the firm level. The analysis focuses on a two-country, one-sector model of intraindustry trade with two factor inputs consisting of high-skilled and low-skilled labor. We find that a move from autarky to free trade (a) raises the output of the representative firm and its level of total factor productivity, and (b) reduces (raises) the relative wage of high-skilled workers under the hypothesis of output-skill substitutability (output-skill complementarity). Plant-level evidence from Mexico supports the empirical relevance of the proposed income-distribution mechanism.     

Lobbying costs and trade policy

We study how endogenous lobbying costs influence trade policies. Although in practice lobbying expenditures far exceed campaign contributions, the literature on the political economy of trade policy has focused on the latter. In this paper we develop a model in which informational lobbying costs play a role in determining the structure of protection. In the model, special interest groups can choose to send a signal to the policymaker regarding some information they possess, and the policymaker observes the signal before setting the trade policies. We find that lobbying expenditures directly affect the equilibrium policies. In order to test the predictions of the model we collected data on lobbying expenditures from the Center for Responsible Politics as well as data on trade and industry characteristic variables for the United States from other sources. We perform a structural estimation of the equilibrium trade policies and find support for our model. The empirical evidence indicates that lobbying expenditures play an important role in explaining the variation of protection across sectors. Moreover, the model leads to considerably lower and more reasonable estimates of the weight that the government places on social welfare relative to political contributions.     

The effects of loss aversion on trade policy: Theory and evidence

We study the implications of loss aversion for trade policy determination and show how it allows us to explain a number of important and puzzling features of trade policy. Some important questions concerning trade policy are why a disproportionate share of protection goes to declining industries and why trade policy has an anti-trade bias. We show that if individual preferences exhibit sufficient loss aversion, higher protection will be given to sectors in which profitability is declining. We also show that if the coefficient of loss aversion is large enough, there will be an anti-trade bias in trade policy. Using a nonlinear regression procedure, we find support for the model and the estimates of the loss aversion parameters are very close to those obtained by Kahneman and Tversky (Kahneman, D., Tversky, A., 1992. Advances in Prospect Theory: Cumulative Representation of Uncertainty. Journal of Risk and Uncertainty 5, 297-323.) with experimental data. Protection is found to be more responsive to losses than to gains, and the estimates of the coefficient of loss aversion are about 2. We also find evidence of loss aversion in lobby formation.     

Protection for sale under monopolistic competition

This paper broadens the protection for sale model of Grossman and Helpman (1994) by incorporating the Krugman-Dixit-Stiglitz model of monopolistic competition, given its importance in explaining the prevalence of intraindustry trade. Several new results arise in this paper. First, the endogenous import tariff will never fall below zero, even in unorganized sectors. Second, the endogenous export policy for organized sectors is not necessarily an export subsidy, and can be an export tax as in unorganized sectors. Third, the level of import protection varies inversely with the degree of import penetration, regardless of whether the sector is organized or not.     

Bilateralism, multilateralism, and the quest for global free trade

We develop an equilibrium theory of trade agreements in which both the degree and the nature (bilateral or multilateral) of trade liberalization are endogenously determined. To determine whether and how bilateralism matters, we also analyze a scenario where countries pursue trade liberalization on only a multilateral basis. We find that when countries have asymmetric endowments or when governments value producer interests more than tariff revenue and consumer surplus, there exist circumstances where global free trade is a stable equilibrium only if countries are free to pursue bilateral trade agreements. By contrast, under symmetry, both bilateralism and multilateralism yield global free trade.     

Innovation and trade with heterogeneous firms

This paper examines how trade liberalization affects the innovation incentives of firms, and what this implies for industry productivity. For this purpose we develop a reciprocal dumping model of international trade with heterogeneous firms and endogenous R&D. Among the robust results that hold both in the short run when there is no entry, and in the long run under free entry are that trade liberalization increases aggregate R&D when trade costs are low and decreases R&D when trade costs are high. Expected industry productivity rises as trade costs fall.     

Labor versus capital in trade-policy: The role of ideology and inequality

Trade policy depends on the extent to which the government wants to redistribute income as well as on a country's overall factor endowments and their distribution. While the government's desire to redistribute income itself is dependent on asset distribution, it is to a large extent also driven by the partisan nature of the government, i.e., whether it is pro-labor or pro-capital. Using cross-country data on factor endowments, inequality and government orientation, we find that, conditional on inequality, left-wing (pro-labor) governments will adopt more protectionist trade policies in capital-rich countries, but adopt more pro-trade policies in labor-rich economies than right-wing (pro-capital) ones. Also, holding government orientation constant, higher inequality is associated with higher protection in capital-abundant countries while it is associated with lower protection in labor-abundant countries. These results are consistent with the simultaneous presence of both inequality as well as ideology as determinants of protection within a two-factor, two-sector Heckscher-Ohlin framework. Overall, various statistical tests support an umbrella model (that combines both the ideology and inequality models) over each of the individual models.