Welfare implications of trade liberalization and fiscal reform: A quantitative experiment

This paper studies the welfare implications of revenue-neutral trade liberalization and fiscal reform programs for developing economies using a multi-sector dynamic general equilibrium model of a small open economy. We analyze how different combinations of tariffs – on imported consumption goods, intermediate inputs, and capital goods – and taxes – on consumption, labor income and capital income – affect the transitional and long-run welfare. We report three main findings. First, trade liberalization programs financed by consumption and labor income taxes tend to result in substantial welfare gains, but financing the lost tariff revenue through capital income taxes can have an adverse impact on welfare. Second, a significant fraction of welfare changes is due to transitional effects stemming from the allocation of resources in response to changes in tariffs and taxes. Third, trade liberalization and fiscal reform programs often translate into much larger welfare gains in countries that are more open to international financial markets.     

Financial liberalization,prudential supervision,and the onset of banking crises

We examine what is perceived as one of the main culprits in the occurrence of banking crises: financial liberalization. As is typically argued, if liberalization is accompanied by insufficient prudential supervision of the banking sector, it will result in excessive risk taking by financial intermediaries and a subsequent crisis. Having evaluated the empirical validity of this hypothesis, we conclude that such a development is, at worse, only a medium run threat to the health of the banking sector. We find that a more immediate danger is the loss of monopoly power that liberalization typically entails. We base our conclusions on an empirical investigation of a panel-probit model of the occurrence of banking crises using macro-economic, institutional and political data.     

Interest rate liberalization and pass-through of monetary policy rate to bank lending rates in China

We examine whether the effectiveness of the monetary policy rate transmission differs before and after interest rate liberalization in China using the autoregressive distributed lag (ARDL) bound test and an error correction model (ECM). The results show that after liberalization the mark-up is lower, and both the long-run and shortrun interest rate pass-through has become faster and more complete. We attribute our findings to the ongoing reforms of China’s banking system, which has improved the competitiveness of Chinese commercial banks.     

Trade and technology adoption

This paper endogenizes firms' choices of production technology in what would be a standard Melitz model otherwise. The responses of firms' productivity to trade liberalization are heterogenous: exporters, on average, improve their level of technology adoption, whereas nonexporters downgrade their level of technology adoption. The degree to which firms adjust production technology depends on domestic market size, export destination market size, trade impediments, and export status. The conflicting empirical results of the impact of trade liberalization on exporters' productivity are rationalized by showing that changes in different trade costs (variable vs. fixed costs) affect firms' productivity differently. We calibrate the model's parameters to match firms' characteristics in the global economy. The results indicate that endogenous productivity increases the gains from trade liberalization.     

External tariffs under a free-trade area

How do free-trade areas affect the tariffs that member countries impose against non-members? There is no consensus in the literature regarding this important question. In this study, we use a political-economy model of endogenous protection to show that if individual preferences exhibit loss aversion or if the government's objective is characterized by diminishing marginal political support, a free-trade area can lead member countries to increase their external tariffs and thus act as a stumbling block to unilateral liberalization. We also argue that the stumbling block result is more likely to arise under loss aversion than under diminishing marginal political support and confirm this using a simulation. Finally, we show that the stumbling block effect can also take place under multilateral liberalization. Our results highlight a new type of mechanism through which preferential trade agreements may affect external tariffs.     

Trade liberalization, product variety and growth in a small open economy: a quantitative assessment

We develop a numerical growth model that quantifies the welfare effects of trade liberalization. Additional intermediate input varieties provide the engine of growth and dramatically magnify the welfare gains from trade liberalization. In our central model, a 10% tariff cut leads to a 10.6% estimated gain in Hicksian EV. Systematic sensitivity analysis shows that there is virtually no chance of a welfare increase less than 3%, but a 6.6% chance of a welfare gain greater than 18%. We show that complementary reforms are crucial to fully realize the potential gains from the trade reform.     

Investment liberalization and international trade

This paper estimates the cross-price elasticity of exports with respect to investment costs for bilateral relations between 36 countries. We show that the effect of reducing foreign direct investment costs on exports depends on country characteristics and trade costs as predicted by the [Markusen, 1997] and [Markusen, 2002] model. When countries differ in relative factor endowments and trade costs are low, investment liberalization stimulates exports, whereas when countries are similar in terms of relative factor endowments and size, and trade costs are moderate to high, investment liberalization reduces exports.     

Trade liberalization and the evolution of skill earnings differentials in Brazil

Skilled labor earnings differentials decreased during the trade liberalization implemented in Brazil from 1988 to 1995. This paper investigates the role of trade liberalization in explaining these relative earnings movements. We perform several independent empirical exercises that check the traditional trade transmission mechanism, using disaggregated data on tariffs, prices, earnings, employment and skill intensity. We find that: i) employment shifted from skilled to unskilled intensive sectors, and each sector increased its relative share of skilled labor; ii) relative prices fell in skill-intensive sectors; iii) tariff changes across sectors were not related to skill intensities, but the pass-through from tariffs to prices was larger in skill-intensive sectors; iv) the decline in skilled earnings differentials mandated by the price variation predicted by trade was even larger than the observed one. The results are compatible with trade liberalization accounting for the observed relative earnings changes in Brazil. They also highlight the importance of considering the effects of differentiated pass-through from tariffs to prices.     

FDI in post-production services and product market competition

Post-production services, such as sales, distribution, and maintenance, comprise a crucial element of business activity. We explore an international duopoly model in which a foreign firm has the option of outsourcing post-production services to its domestic rival or providing those services by establishing its own facilities through FDI. We demonstrate that trade liberalization in goods may hurt domestic consumers and lower world welfare, and that the negative welfare impacts are turned into positive ones if service FDI is also liberalized. This finding yields important policy implications, given the reality that the progress of liberalization in service sectors is still limited.     

Good jobs, bad jobs, and trade liberalization

How do labor markets adjust to trade liberalization? Leading models of intraindustry trade (Krugman (1981), Melitz (2003)) assume homogeneous workers and full employment, and thus predict that all workers win from trade liberalization, a conclusion at odds with the public debate. Our paper develops a new model that merges Melitz (2003) with Shapiro and Stiglitz (1984), so also links product market churning to labor market churning. Workers care about their jobs because the model features aggregate unemployment and jobs that pay different wages to identical workers. Simulations show that, for reasonable parameter values, as many as one-fourth of existing “good jobs” (those with above average wage) may be destroyed in a liberalization. This is true even as the model shows minimal impact on aggregate unemployment and quite substantial aggregate gains from trade.     

Does financial liberalization reduce income inequality? Evidence from Africa

This paper investigates the impact of financial liberalization on income inequality by using the country-level panel data from 51 African countries in more than two decades. We find that income inequality increases, rather than decreases, with the level of financial liberalization. This finding is consistent with the hypothesis that financial liberalization likely induces banks to allocate the scarce financial resources in African countries more discriminatively to rich clienteles but excludes the poor ones from financial access, which thus widens the income gap.     

Timing of trade liberalization

Abstract

This paper studies the effects of trade liberalization on growth and long-run global income inequality using a two-country model of human capital accumulation by credit-constrained households. I show that the timing of trade liberalization is a crucial determinant of its effects on growth. Moreover, I show that the size of the long-run income gap between the two countries depends on the difference in domestic income inequality when they open up to trade. Based on these results, I analyze the effects of redistributive policy within a country. I show that redistribution in one country may increase income per capita of its trading partner if it is undertaken in a steady state, while the opposite is true if the policy is undertaken during transition.     

A gravity model to account for vertical linkages between markets with an application to the cattle/beef sector

A gravity model is developed to explain bilateral trade flows in primary and processed commodities within the same agri-food supply chain. It accounts for vertical production linkages, trade and domestic policies, and supply rigidities at the farm level. Our application focuses on cattle/beef trade flows between 42 countries. The estimated parameters of the model are used to simulate trade flows. We found large differences in the impacts of the full and partial liberalization scenarios. A parametric bootstrap procedure is used to generate confidence intervals around predicted trade liberalization outcomes.     

Charting the pacific: an empirical assessment of integration initiatives

Trade negotiations after Uruguay may well be dominated by the Pacific Rim, where two free trade areas (ASEAN Free Trade Agreement, or AFTA; and North American Free Trade Agreement, or NAFTA) already exist and larger agreements are under active discussion (involving the Asia Pacific Economic Cooperation, or APEC, area and an East Asian Economic Group). This article analyzes several initiatives using a simple global general equilibrium model that incorporates conventional welfare gains as well as benefits derived from firm level economies of scale, induced changes in foreign investment, and dynamic increases in productivity. Broad Pacific liberalization—i.e., East Asia, North America, and Australasia—is shown to be superior for each participant to liberalization limited to individual countries or East Asia, but not by much. Most favored nation liberalization is shown to be superior for each participant to preferential liberalization—if the actor is East Asia, but not the Pacific as a whole. These estimates will need to be refined, but they suggest that the benefits from Pacific liberalization could exceed $100 billion per year.     

Product quality,firm heterogeneity and trade liberalization

This paper develops a framework for studying the general equilibrium effects of endogenous quality upgrading, a new margin of trade, on the welfare impact of trade liberalization. The theoretical model introduces product quality differentiation amongst heterogeneous firms and focuses on supply-side determinants of international trade. Among other results, in general equilibrium, trade liberalization decreases the share of high-quality varieties in exports and the average productivity of exporters. These changes affect average export price in opposite ways. Nevertheless, trade liberalization in the quality-extended model increases consumers’ welfare by more than in the benchmark model.     

The Effects of Ownership Structure on Corporate Financing Decisions: Evidence from Stock Market Liberalization

We analyze the impact of firm‐specific stock market liberalization events on the capital structure and debt maturity decisions of firms from emerging market economies. We differentiate between firms based on their ownership structures at the time of liberalization and analyze their post‐liberalization behavior regarding corporate financing decisions. Our empirical results show that single–class‐share firms (typically with stronger corporate governance and better information environments) respond differently to their dual–class‐share counterparts. Liberalization results in lower debt reliance for the former group while the latter lengthen the maturity of their debt portfolios. Jel Classification: F30; G15; G32.     

Trade liberalization and organizational change

We embed a simple incomplete-contracts model of organization design in a standard two-country perfectly-competitive trade model to examine how the liberalization of product and factor markets affects the ownership structure of firms. In our model, managers decide whether or not to integrate their firms, trading off the pecuniary benefits of coordinating production decisions with the private benefits of operating in their preferred ways. The price of output is a crucial determinant of this choice, since it affects the size of the pecuniary benefits. Organizational choices also depend on the terms of trade in supplier markets, which affect the division of surplus between managers. We show that, even when firms do not relocate across countries, the price changes triggered by the liberalization of product markets can lead to changes in ownership structures within countries. The removal of barriers to factor mobility can also induce widespread restructuring, which can lead to increases in product prices (or declines in quality), hurting consumers worldwide.     

The impacts of trade liberalization on informal labor markets: A theoretical and empirical evaluation of the Brazilian case

Following trade liberalization, several developing countries experienced a sharp increase in the share of informal manufacturing employment. In this paper, I examine the impacts of trade liberalization on the labor markets of a small open economy, in an environment in which tariffs affect firms' payroll tax compliance decisions. I demonstrate that a reduction in domestic import tariffs reduces the average formal wage and show that the direction of the effect on the share of informal employment depends on the initial labor market conditions. A cut in trading partner import tariffs decreases the share of domestic informal employment and increases the average formal wage. I confirm the model's principal findings empirically, using data from the 1989–2001 Brazilian trade liberalization episode. I find the results robust to endogeneity and self-selection concerns, which are addressed, respectively, using instrumental variable and switching regression approaches.     

Trade liberalization and the environment: The case of intra-industry trade

Abstract

While a large body of literature examines the environmental impact of trade on the environment, this discussion focuses largely on the context of inter-industry trade. Empirical evidence has long suggested that an increasing share of international trade takes the form of intra- rather than inter-industry trade. In an attempt to fill this gap, the present paper uses a price-setting duopoly model of intra-industry trade to highlight the environmental consequences of trade liberalization when oligopolistic rivalry rather than comparative advantage drives international trade. We find that the environmental impact of trade liberalization depends mostly on two factors, namely, on the nature of pollution (i.e. whether it is local, transboundary or global) and on which country liberalizes trade (i.e. whether it is the ‘clean’ country or the ‘dirty’ country).     

Trade and foreign direct investment in China: a political economy approach

We view the political process in China as trading off the social benefits of increased trade and foreign direct investment against the losses incurred by state-owned enterprises due to such liberalization. A model drawing on Grossman and Helpman [Am. Econ. Rev. 84 (1994) 833; The Political Economy of Trade Policy: Papers in Honor of Jagdish Bhagwati, MIT Press, Cambridge (1996) 199] is used to derive an empirically estimable government objective function. The key structural parameters of this model are estimated using province-level data on foreign direct investment and trade flows in China, over the years 1984-1995. We find that the weight applied to consumer welfare is between one-seventh and one-quarter of the weight applied to the output of state-owned enterprises.