Product and process productivity: Implications for quality choice and conditional exporter premia

We develop a model of international trade with two dimensions of firm heterogeneity. The first dimension is “process productivity”, which is how we denote the standard concept of productivity as modeled in the literature. The second one is “product productivity”, defined as firms' ability to develop high-quality products spending small fixed outlays. The distinction between these two sources of productivity, together with the assumption that iceberg trade costs decrease with quality, delivers various conditional exporter premia as theoretical predictions. Conditional on size, exporters sell higher quality products, charge higher prices, pay higher input prices and higher wages, and use capital more intensively. Some of these predictions had already been documented in the empirical literature but lacked a theoretical framework for properly interpreting them. We conduct systematic tests of these predictions using manufacturing establishment data for India, the U.S., Chile, and Colombia, and find strong support for the model.     

The dynamics of trade and competition

We estimate a version of the Melitz and Ottaviano [Melitz, Marc J. and Ottaviano, Gianmarco I.P., 2008, Market size, trade, and productivity, Review of Economic Studies 75(1), pp. 295-316.] model of international trade with firm heterogeneity. The model is constructed to yield testable implications for the dynamics of prices, productivity and markups as functions of openness to trade at a sectoral level. The theory lends itself naturally to a difference in differences estimation, with international differences in trade openness at the sector level reflecting international differences in the competitive structure of markets. Predictions are derived for the effects of both domestic and foreign openness on each economy. Using disaggregated data for EU manufacturing over the period 1989-1999 we find short run evidence that trade openness exerts a competitive effect, with prices and markups falling and productivity rising. The response of profit margins to openness has implications on the conduct of monetary policy. Consistent with the predictions of some recent theoretical models we find some, albeit weaker, support that the long run effects are more ambiguous and may even be anti-competitive. Domestic trade liberalization also appears to induce pro-competitive effects on overseas markets.     

The elasticity of trade: Estimates and evidence

Quantitative results from a large class of structural gravity models of international trade depend critically on the elasticity of trade with respect to trade frictions. We develop a new simulated method of moments estimator to estimate this elasticity from disaggregate price and trade-flow data and we use it within Eaton and Kortum's (2002) Ricardian model. We apply our estimator to disaggregate price and trade-flow data for 123 countries in the year 2004. Our method yields a trade elasticity of roughly four, nearly fifty percent lower than Eaton and Kortum's (2002) approach. This difference doubles the welfare gains from international trade.     

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.     

Corporate hierarchies and international trade: Theory and evidence

Corporate organization varies within countries and between countries. We develop a theory which explains the variation in levels of decentralization across firms and links it to the trade environment that firms face. We introduce firms with internal hierarchies in a Melitz and Ottaviano (2008) model of international trade. We show that international trade increases the conflict of interest between CEO/owners and middle managers within firms and these eventually lead to decentralized corporate hierarchies. We test the theory with original data on the internal organizations of 2200 Austrian and German firms and find that the empirical evidence is consistent with the model's predictions.     

International trade and child labor: Cross-country evidence

We explore the relationship between exposure to trade (as measured by openness) and child labor in a cross-country setting. Our methodology accounts for the fact that trade flows are endogenous to child labor (and labor standards more generally) by examining the relationship between child labor and variation in trade based on geography. We find that countries that trade more have less child labor. At the cross-country means, the data suggest an openness elasticity of child labor of − 0.7. For low-income countries, the elasticity of child labor with respect to trade with high-income countries is − 0.9. However, these relationships appear to be largely attributable to the positive association between trade and income. We consistently find a small and statistically insignificant association between openness and child labor when we control for cross-country income differences in the full sample, when we split the sample into different country groups, consider only trade between high- and low-income countries, or focus on exports of unskilled-labor intensive products from low-income countries. Thus, the cross-country data do not substantiate assertions that trade per se plays a significant role in perpetuating the high levels of child labor that pervade low-income countries.     

The effect of trade liberalization on child labor

The question of how trade liberalization affects the employment of children in developing economies is at the core of the debate on globalization. Trade theory predicts that an increase in the price of an exported good could either increase or decrease child labor depending on the magnitudes of the substitution and income effects. In this paper, we study the relationship between changes in the relative price of an exported commodity and child labor using household-level data from within a poor country. In particular, we relate child labor to regional and intertemporal variation in the real price of rice surrounding national and international rice market integration in Vietnam. We find that higher rice prices are associated with declines in child labor. Income effects play an important role in this relationship. Rice price increases are associated with the largest declines in child labor in households that are large net producers of rice. These findings show that greater market integration can be associated with less child labor. Moreover, our results suggest that the use of punitive trade sanctions on exports from developing countries to eradicate child labor is unlikely to yield the desired outcome.     

Firm and sectoral heterogeneity in markup variability

Many theoretical models assume that the markup of price over marginal costs is the same for all firms in a sector, irrespective of firm size, type, or efficiency. We analyze the distribution of markups for 70 Finnish sectors using a complete dataset, including both manufacturing and services sectors and firms of all sizes. In contrast to the constant markup hypothesis, we find (i) large differences in markups within sectors, (ii) higher markups for small firms and domestic firms, and (iii) greater markup heterogeneity in sectors with low capital-labour ratios and a large number of firms.     

The impact of trade liberalization on productivity: Evidence from India's formal and informal manufacturing sectors

Despite a large literature investigating the impacts of trade on firm productivity, there is almost no evidence on how small firms react to trade liberalization. Using a unique dataset of firm-level surveys that are representative of the entire Indian manufacturing industry, I show that India's unilateral reduction in final goods tariffs increased the average productivity of small, informal firms, which account for 80% of Indian manufacturing employment but have been excluded from previous studies. In contrast, the increase in productivity among larger, formal firms was driven primarily by the concurrent reduction in input tariffs. By examining the effect of the tariff liberalization on the distributions of productivity and firm size, I find evidence consistent with the exit of the smallest, least productive firms from the informal sector. In addition, I find that although the decline in final goods tariffs did not significantly impact average formal sector productivity, it did increase productivity among the top quantiles of the distribution.     

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.     

Realizing the gains from trade: Export crops, marketing costs, and poverty

This paper explores the role of export costs in the process of poverty reduction in rural Africa. We claim that the marketing costs that emerge when the commercialization of export crops requires intermediaries can lead to lower participation into export cropping and, thus, to higher poverty. We test the model using data from the Uganda National Household Survey. We show that: i) farmers living in villages with fewer outlets for sales of agricultural exports are likely to be poorer than farmers residing in market-endowed villages; ii) market availability leads to increased household participation in export cropping (coffee, tea, cotton, fruits); iii) households engaged in export cropping are less likely to be poor than subsistence-based households. We conclude that the availability of markets for agricultural export crops help realize the gains from trade. This result uncovers the role of complementary factors that provide market access and reduce marketing costs as key building blocks in the link between the gains from export opportunities and the poor.     

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.     

Heterogeneous firm-level responses to trade liberalization: A test using stock price reactions

This paper presents novel empirical evidence on key predictions of heterogeneous firm models by examining stock market reactions to the Canada–United States Free Trade Agreement of 1989 (CUSFTA). I derive testable predictions for a class of models based on Melitz (2003). Using the uncertainty surrounding CUSFTA's ratification, I show that the pattern of abnormal returns of Canadian manufacturing firms was strongly consistent with predictions related to export (U.S.) tariff reductions, but less so with predictions related to import (Canadian) tariff reductions. Lower Canadian tariffs did have an effect through the implied reduction in intermediate input tariffs, however.     

Ricardian-Heckscher-Ohlin comparative advantage: Theory and evidence

This paper derives and estimates a unified and tractable model of comparative advantage due to differences in both factor abundance and relative productivity differences across industries. It derives conditions under which ignoring one force for comparative advantage biases empirical tests of the other. I emphasize two empirical results: First, factor abundance- and relative productivity-based models each possesses explanatory power when nesting the other as an alternate hypothesis. Second, productivity differences across industries do not bias tests of the HO model in my sample. However, I find weak and mixed evidence that Heckscher-Ohlin forces can potentially bias tests of the Ricardian model.     

Product quality and the direction of trade

A substantial amount of theoretical work predicts that quality plays an important role as a determinant of the global patterns of bilateral trade. This paper develops an empirical framework to estimate the empirical relevance of this prediction. In particular, it identifies the effect of quality operating on the demand side through the relationship between per capita income and aggregate demand for quality. The model yields predictions for bilateral flows at the sectoral level and is estimated using cross-sectional data for bilateral trade among 60 countries in 1995. The empirical results confirm the theoretical prediction: rich countries tend to import relatively more from countries that produce high-quality goods.     

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.     

The impact of parallel imports on investments in cost-reducing research and development

We develop a two-country model of endogenous investment in process innovation by a manufacturer facing competition from parallel imports (PI). We find that the distortions associated with PI inhibit innovation. However, the difference between the manufacturer's expected profits under successful and failed innovation is U-shaped in the cost of engaging in PI. Thus, the reduction in R&D investment depends on both legality of PI and transport costs. The reduction in innovation could harm global welfare, depending on whether the manufacturer was deterring PI with a high wholesale price. If so, banning such trade would raise expected welfare.     

Estimating the effects of free trade agreements on international trade flows using matching econometrics

This paper provides the first cross-section estimates of long-run treatment effects of free trade agreements on members' bilateral international trade flows using (nonparametric) matching econometrics. Our nonparametric cross-section estimates of ex post long-run treatment effects are much more stable across years and have more economically plausible values than corresponding OLS cross-section estimates from typical gravity equations. We provide plausible estimates of the long-run effects of membership in the original European Economic Community (EEC) and the Central American Common Market (CACM) between 1960 and 2000 and the estimates confirm anecdotal reports of these agreements' effectiveness.     

Trade, demand spillovers, and industrialization: The emerging global middle class in perspective

In this paper, we investigate international demand spillovers brought about by a global middle class and their impact on trade patterns and industrialization. We propose a multi-industry and two-country trade model featuring demand complementarities propagating increasing returns across industries and national boundaries. We show how the international extent of demand spillovers depends upon asymmetries in domestic income distribution, labor efficiency, and labor force size; that is, on the global distribution of real income.     

Endogenous free trade agreements and the multilateral trading system

I evaluate in this paper the impact of free trade areas (FTAs) on the world trading system. I use an oligopolistic-political-economy model where the external tariffs of FTA members, as well as the decision to form FTAs, are endogenously determined. In this context, I show that FTAs are primarily beneficial to the multilateral trading system. This conclusion is based, first, upon the finding that FTAs induce their member governments to lower their external tariffs, and to do so deeply enough to enhance trade even between FTA members and non-members. While this ensures gains for the latter, in general FTA members may not gain. I show, however, that governments will endorse only welfare-improving arrangements, in spite of their political motivations; as a result, FTA members benefit from ratified arrangements as well. Finally, I find that FTAs, by reducing the role of special interests criteria in governments' trade regime decisions, also tend to enhance support for further liberalization at the multilateral level.