Citizen Preferences over trade & what governments might do about it INTERNATIONAL BUSINESS...

Citizen Preferences over trade& what governments might do about it

INTERNATIONAL BUSINESS ENVIRONMENT Course numbers STRT 571-44 & -45, Spring 2010, Mod 4

James Raymond Vreeland, School of Foreign Service

Week 3 (Monday, 29 March; Wednesday, 31 March)

Tonight’s schedule

• 6:30-7:30

• 5 minute break

• 7:35-8:35

• 5 minute break

• 8:40-9:40

Plan for tonight:

1. Why do countries engage in trade?

2. Why does a country have a “comparative advantage” in one industry but not another?

3. Why is there protectionism?

4. Who is against immigration?

5. Is it factors or sectors?

6. What role do domestic political institutions play?

7. What industrial policies have states pursued?

8. What role do international political institutions play?

Who is this guy?

WEGG

Why do countries engage in trade?

• Ricardian model: 2 countries, 2 goods & CONSTANT opportunity costs

• Logic of COMPARATIVE ADVANTAGE

• One American worker can produce more computers or more shoes than one Brazilian worker

• US has an ABSOLUTE ADVANTAGE in both computers and shoes

• So why trade?

Differences in opportunity costs!

• Suppose we move one American worker from Computers to Shoes

• We lose 50 computers for 200 shoes

• For each additional pair of shoes produced, the US must forgo 0.25 computers (50/200=¼)

• The (constant) opportunity cost of each pair of shoes is ¼ computer

• The (constant) opportunity cost of each computer is 4 pairs of shoes (200/50=4)

Differences in opportunity costs!

• Suppose we move one Brazilian worker from Computers to Shoes

• We lose 5 computers for 175 shoes

• For each additional pair of shoes produced, Brazil must forgo 0.03 computers (5/175=0.029)

• The (constant) opportunity cost of each pair of shoes is 0.03 computer

• The (constant) opportunity cost of each computer is 35 pairs of shoes (175/5=35)

Critical point

• Where is it RELATIVELY cheaper to produce computers?– In the US it costs 4 shoes– In Brazil it costs 35 shoes

• Where is it RELATIVELY cheaper to produce shoes?– In the US it costs ¼ computer– In Brazil it costs 0.03 computer

Why does one country have a comparative advantage in one area?

• Heckscher-Ohlin:

• Compared to the availability of capital & labor in one country, another country will have relatively more or less

• Capital-abundant countries: Cost of capital relative to wages is lower

• Labor-abundant countries: Wages relative to cost of capital is lower

• H-O suggests that countries have an advantage in producing different commodities because of the different factor endowments of countries and the different mixtures of these factors involved in production of different commodities

Question regarding “relatively capital abundant” vs “relatively labor abundant” … “relative” to what?

• Other countries? Or relative to the other factor?

• Answer: other factor

So why is there protectionism?

Winners & Losers

• Trade has distributional consequences!

• Trade policy is shaped by government’s responses to interest groups’ demands

• Government responses to interest groups are shaped by POLITICAL INSTITUTIONS

• Strength of the interest group depends on its resources & size (effect of size???)

Factor incomes & class conflict

• Simplest version:– labor v. capital– (workers v. owners of capital)

• Countries have a comparative advantage in producing goods requiring their ABUNDANT FACTOR

• There are capital-abundant countries & labor abundant countries

• When the US opens up to trade, they move from producing at EaA to PtA.

• So they shift from shoes to computers.

• Who gains?– Capital

• Who loses?– Labor

• When the US opens up to trade, they move from producing at EaB to PtB.

• So they shift from computers to shoes.

• Who gains?– Labor

• Who loses?– Capital

In the factor model, trade causes…

• Income of the ABUNDANT factor to RISE

• Income of the SCARCE factor to FALL

• Absent trade– “Capital” is relatively scarce in a country like

China, so the “rent” can be enormous– Labor is abundant, so wages are low

• By opening up to trade– Capital “rents” will fall until they equals the

(rising) rate of return in trading partner countries

– Wages will rise until they equal the (falling) wage in trading partner countries

• Absent trade– Labor is relatively scarce in a country like

Switzerland, so wages can be enormous– Capital is abundant, so returns are low

• By opening up to trade– Return to capital will rise until it equals the

(dropping) rate in trading partner countries– Wages will drop until they equal the (falling)

wage in trading partner countries

Stolper-Samuelson Theorem

• Factor-price equalization

• The tendency for trade to cause factor prices to converge

• Note that the losses for the scarce factor are NOT sufficiently offset by gains from trade (even if the net aggregate gains offset net aggregate losses).

• The scarce factor is a net LOSER!

What do we do about losers?

• Repress them?– Dictatorship – repression?– Democracy – tyranny of the majority?

• Compensate them?– Training?– Retirement packages?

• Protect them?– Tariffs, barriers to trade, subsidies

• The answer may depend on political institutions!

Thought experiment

• Suppose 2 factors of production – (labor & capital)

• The majority of citizens are “labor”

• Under democracy, labor rules

• Under dictatorship, capital rules

• Question: Will the government be pro-trade or not?

Democracy Authoritarian

Capital abundant ???

Labor abundant

Back to 2 factors (ignoring collective action problem)

Democracy Authoritarian

Capital abundant Labor loses from trade but has political power protectionism

Labor abundant ???

Back to 2 factors (ignoring collective action problem)

Democracy Authoritarian

Capital abundant Labor loses from trade but has political power protectionism

???

Labor abundant Labor wins from trade & has political power free trade

Democracy Authoritarian

Capital abundant Labor loses from trade but has political power protectionism

Capital wins from trade & has political power free trade

Labor abundant Labor wins from trade & has political power free trade

???

Back to 2 factors (ignoring collective action problem)

Back to 2 factors (ignoring collective action problem)

Democracy Authoritarian

Capital abundant Labor loses from trade but has political power protectionism

Capital wins from trade & has political power free trade

Labor abundant Labor wins from trade & has political power free trade

Capital loses from trade but has political power protectionism

• Rogowski, Ronald. 1987. Political Cleavages and Changing Exposure to Trade. American Political Science Review 81 (4):1121-1137.

• 3 factors: land-labor-capital– Considers the land-labor ratio– High land-labor ratio land-abundant, labor-scarce– Low land-labor ratio labor-abundant, land-scarce– Define “advanced” economies as capital-abundant

Pro-trade

Anti-trade

Pro-trade

Anti-trade

Pro-trade

Anti-trade

Pro-trade

Anti-trade

URBAN-RURAL CONFLICT

URBAN-RURAL CONFLICT

CLASS CONFLICT

CLASS CONFLICTExamples:

Peron in Argentina,

Vargas in Brazil

Does the factor-approach predict preferences over “globalization”?

Trade, immigration…

Effect of education on pro-trade attitude by country-factor endowment

Effect of occupational skill on pro-trade attitude by ctry-factor endowment

5 minute break

Who is against immigration?

Mayda, Anna Marie. 2006. Who is Against Immigration? A Cross-Country Investigation of Individual Attitudes toward Immigrants. The Review of Economics and Statistics 88 (3):510-530.

Answer/Theory:• Heckscher-Ohlin model predicts that immigration attitudes depend on the

impact on factor prices of changes in relative factor supplies due to immigration.

• So, if factor-price-sensitivity holds (assuming that capital is internationally mobile):

• The correlation between immigration attitudes and individual skill should be related to the skill composition of natives relative to immigrants in the destination country

• If skilled and unskilled labor are complements, skilled individuals should favor immigration if the average skill level of *natives* is higher than the average skill level of immigrants,

– immigration will reduce the relative supply of skilled to unskilled labor and raise the skilled wage

• The opposite is true for countries where natives are on average less skilled than immigrants

• If skilled and unskilled labor are complements, skilled individuals should _______ immigration if the average skill level of *natives* is ________ than the average skill level of immigrants

– immigration will _______ the relative supply of skilled to unskilled labor and ________ the skilled wage

• (“oppose,” “lower,” “raise,” “lower”)

Theory: The Prediction

• In countries characterized by *high skill* composition of natives relative to immigrants,

– *skilled* individuals should favor immigration

– *unskilled* individuals should oppose immigration

• In countries characterized by *low skill* composition of natives relative to immigrants,

– *unskilled* individuals should favor immigration

– *skilled* individuals should oppose immigration

Test the theory using empirical evidence

• Finding: Skilled individuals are more likely to be pro-immigration in countries where the skill composition of natives relative to immigrants is high– Rich countries are more likely to receive immigrants who are less

skilled than natives – Poor countries are more likely to receive immigrants who are more

skilled than natives

• Mayda uses GDP & education as measures of the “skill level”

• Why two data sets?– The 1995 National Identity module of the International Social Survey

Programme and the third wave of the World Value Survey data set contains more detailed data on 22 countries (mostly developed economies)

– The second data source gives less detailed data on 44 countries (mostly developing countries

• In the small sample: a direct measure of the relative skill composition of natives to immigrants

• Requires information on immigrants & natives skill level

• For the larger sample relies on GDP as a proxy for the native skill composition

The skill composition of natives to immigrants is positively correlated with GDP per capita (level of development.

The effect of education (skill) is stronger in more developed countries.

The effect of education appears to be economically not culturally driven – holds only for people in the labor force

Effect of education on pro-immigration attitude by ctry-factor endowment

Effect of education on pro-immigration attitude by ctry-factor endowment

Alternative explanations?• Non-economic variables also are found to be significantly correlated

with immigration policy preferences

• Concerns regarding the impact of immigration on crime rates and individual perceptions of the cultural effect of foreigners covary with immigration attitudes

• Racist feelings have a very strong, negative and significant impact on pro-immigration preferences

• However, these non-economic determinants do not seem to alter significantly the results regarding the economic variables

– economic findings are "robust" to the inclusion of cultural variables

• Important (and sad): Mayda finds that non-economic determinants are relatively more important than the economic variables considered, in terms of the amount of variance the model explains– R2 of model with/without the economic variables increases 6%– R2 of model with/without the cultural variables increases 15%

Summing up immigration findings• Mayda’s work confirms Heckscher-Ohlin (with factor-

price-sensitivity)

Holding other (cultural) factors constant:

• In countries characterized by *high skill* composition of natives relative to immigrants,– *skilled* individuals favor immigration– *unskilled* individuals oppose immigration

• In countries characterized by *low skill* composition of natives relative to immigrants,– *unskilled* individuals favor immigration– *skilled* individuals oppose immigration

• Cultural factors matter more than H-O variables

Is it FACTORS or SECTORS?

Factor mobility

• The ease with which labor and capital can move from one industry to another

• We have implicitly assumed that capital and labor are highly MOBILE

• All capital is the same (computers, car factories, etc…)

• All labor is the same (shoe-makers, furniture-makers, steel-workers, etc…)

• But what if factors are highly SPECIFIC?

Sector Incomes & Industry Conflict

• It’s really about computers, shoes, etc…

• Factor mobility is low

• Incomes of labor AND capital in the same SECTOR (industry) rise and fall together

• Now we do not completely abandon the factor model

• We still use the factor model to tell us which industries benefit from trade, however,…

• LABOR & CAPITAL EMPLOYED IN INDUSTRIES THAT RELY INTENSIVELY ON SOCIETY’S ABUNDANT FACTOR BOTH GAIN FROM TRADE

Advanced industrial countries

• Capital abundant, so…

• Capital AND labor employed in capital-intensive industries both gain from trade

• The export-oriented SECTOR

• Capital AND labor employed in labor-intensive industries both lose from trade

• The import-competing SECTOR

Developing countries

• Labor abundant, so…

• Capital AND labor employed in _______-intensive industries both gain from trade

• The export-oriented SECTOR

• Capital AND labor employed in _______- intensive industries both lose from trade

• The import-competing SECTOR

Rural sector loses from free trade in Korea…

• http://www.youtube.com/watch?v=Z-WOikcNwsM&feature=related

Summarizing factors & sectors

• Factor model (abundant factor wins, scarce loses)

• Sector model (both factors in an abundant-factor-sector win; both factors in a scarce-factor-sector lose)

• What do we about losers?

– Institutions matter!

A State-Centered Approach to the Politics of Trade

5 minute break

A State-Centered Approach

Industrial policy

• The use of a set of instruments – tax policy, subsidies, tariffs (protectionism), government procurement practices – to channel resources away from some industries and direct resources toward the industries the government chooses to promote.

Developmental rationale??

• The shift of resources from agriculture to manufacturing would not occur unless the state adopted appropriate industrial policy

• (But the real reason might have had to do with domestic politics…)

Import Substitution Industrialization

• Industrialize by substituting domestically produced goods for manufactured items they previously imported

• Typically called “ISI”

Easy ISI

• Develop domestic manufacturing of simple consumer goods

• Soda, beer, apparel, shoes, furniture

• Why “easy”?1. Large domestic demand preexisting

2. Technology (machines) required for their production could be easily acquired (purchased from industrial countries

3. Their production relies on low-skilled labor (mobile – bring people from rural agricultural work into factories)

Asia & Latin America• Both practiced “easy” ISI

• But then Asian countries switched to an EXPORT-ORIENTED STRATEGY:

• Producing manufactured goods that can be sold in international markets

• So rather than produce exclusively for the domestic market, they export

• Latin America moved to SECONDARY ISI…

SECONDARY ISI

• Production of consumer durable goods, intermediate inputs, and the capital goods needed to produce consumer durables

• E.g., automobiles (Argentina, Brazil, Chile)

• Begin by importing auto pieces and assembling them domestically

• Gradually, increase the % of locally produced parts

Government policies to promote ISI• Trade barriers

• Investment in activities the private sector would not produce: – Roads, transportation networks, electricity,

telecommunications– Large-scale operations – steel plants, auto plants

• State-owned Enterprises (& mixed-owned)– Chemical, telecommunications, electricity, railways,

metal fabrication

• Tax policies:– “Taxed” agricultural exports through “Marketing Boards”– Marketing Board – purchased crops from farmers at

below-world market prices, then sell them on the world market at world market prices

• Generally, developing countries are abundantly endowed with land and poorly endowed with capital…

• Agriculture is the ________-________ sector– EXPORT ORIENTED SECTOR

• Manufacturing is the ________-________ sector– IMPORT-COMPETING SECTOR

• So, land-owners should be ___-free-trade– PRO-

• Owners of capital should be ___-free-trade– ANTI-

Recall Rogowski’s model

• Capital is a highly “specific factor”

• Land is a highly “specific factor”

• (In his model, labor is a mobile factor)

Pro-trade

Anti-trade

Pro-trade

Anti-trade

Pro-trade

Anti-trade

Pro-trade

Anti-trade

URBAN-RURAL CONFLICT

URBAN-RURAL CONFLICT

CLASS CONFLICT

CLASS CONFLICTExamples:

Peron in Argentina,

Vargas in Brazil

Closer look @ Brazil• Labor-abundant, capital scarce

• Late 19th century – slave labor

• 1877-78 Grande Seca (Great Drought) in the cotton-growing northeast, led to major turmoil, starvation, poverty and internal migration

• Slavery abolished 1884

• Still, primary commodities – #1: Coffee – dominate until the Great Depression

• Drop in prices hurt land owners again – this time a coup

• 1930 Getulio Vargas

• Pursues the easy ISI stage – Protectionism promotes light manufacturing

• Transition to 2ndary ISI in 1950s…

Consumption of capital goods in Brazil

60%

35%

10%

0%

20%

40%

60%

80%

1949 1959 1964

Year

% im

po

rte

d

http://www.youtube.com/watch?v=cbOdUqf-mUI

Shift from ISI to “neoliberalism” & export-oriented industrialization

• Why the shift? – ISI generated economic imbalances (current account

deficits)

– Group of East Asian countries outperformed rest of the world

• Neoliberal?• Export-Oriented• Cold War allies?

– Latin American Debt Crisis led to Structural Adjustment programs of the IMF

ISI problems & the current account

• Current account:– Registers a country’s imports & exports of both

goods and services– Deficit means imports>exports

• How did ISI lead to deficits?1. Manufactured goods were not globally competitive –

only sold domestically

2. Marketing Boards weakened agriculture

3. Governments preferred overvalued exchange rates (contributed to making exports less competitive)

Pro-trade

Anti-trade

URBAN-RURAL CONFLICT

Why was it hard to break free of ISI?

Ghana 1971/2• http://rulers.org/rulg1.html#ghana

• Prime Minister devalued the exchange rate– Rulers.org – 1972: Edward Akufo-Addo, 31 Aug

1970 - 13 Jan 1972

– DEPOSED IN A COUP days after the devaluation!

– Urban residents contributed in the coup effort – concerned that prices for imported goods would rise

– The new regime restored the overvalued XR

– (IMF arrangements: ’66, ’67, ’69, … 1979)

Example: Nigeria 1983• President Shagari, facing an economic crisis, turned to the

IMF hoping to initiate some reforms.

• He faced opposition in the legislature & elections on the horizon.

• The president’s officials admitted, “the whole idea of bringing in the IMF is to get the alibis to persuade the politicians of what we need to do.”

• But the demands of the IMF were too harsh, considering the president’s political constraints.

• No agreement was concluded.

• Side note: the democratic regime soon collapsed & the new dictator pushed through reforms without the IMF. When the dictatorship finally requested an IMF loan in ’87, it was granted.

How did governments keep the system going until the 1980s?

• Foreign loans

• Bilateral aid

• IMF loans

• Were politically important countries “hurt” in the long-run?

• Perverse impact of foreign aid

The East Asian Model• Export-oriented strategy

• Scholars disagree on the role of the state– Neoliberal interpretation: East Asian success due to market friendly

development strategies– State-oriented interpretation: East Asian success due to state-led industrial

polices

• Post-war period: “easy ISI”

• Late 1950s / Early 1960s: shift emphasis to exports.– Forced manufacturers to worry about international competitiveness– Invested resources in domestic industries that were profitable in world

markets (Latin American & African countries did not)

• Relied on protectionism for their domestic markets

• BUT allowed selective liberalization to lower costs for “critical inputs”

• Stable macroeconomic environment:1. Low inflation

– Helps encourage savings2. Appropriately valued exchange rates

– Helps promote exports3. Conservative fiscal policies (borrowed little)

3 Stages of the East Asian Model of Development

1. Industrial policy promotes labor-intensive light industry (easy ISI – e.g., textiles)

2. Target heavy industries (e.g., steel, shipbuilding, petrochemicals)

3. Target high skill plus R&D-intensive industries (e.g., computers)

Using monetary policy to promote exports:

• Exporting firms paid interest rates of 6-12%

• Other borrowers paid 20-22%

• Short-term loans unlimited for confirmed export orders

• Credit also made available to exporters’ input suppliers (and the suppliers’ suppliers)

• Created “free-trade zones” / “export processing zones”

Was success due to markets or states?

• Centralized or Decentralized mechanisms of allocation?

• Mix?

• Used industrial policy to shift resources to the export industry

• Used world markets to “get prices right” for export industry

• Emphasized exports rather than the domestic markets

The Empire Strikes Back

• Governments needed to do less in areas where markets work reasonably well

• Stable macroeconomic environment – – transform budget deficits into surpluses; raise

interest rates; devalue the exchange rate cut demand; change current account

deficits into surpluses

• Liberalize trade

• Privatize State-Owned Enterprises

Structural Adjustment… or…

Role of domestic politics

• Losers attempted to block reforms

• Winners attempted to promote reforms

• Governments mediated between winners & losers

• (Brought in the IMF to help push through reforms?)

Executive

Without the IMF

With the IMF

Veto player

Accept

Reject

Payoff to veto player

-1 (change policy)

0 (maintain the status quo)

-r (reject the IMF)

Figure 1: The logic of bringing in the IMF

Veto player

Accept

Reject

-1 (change policy) + loan

How does bringing in the IMF help push through economic reform?

• Reform involved an intense distributive struggle reforms were implemented unevenly

• PARTIAL REFORM!

– Vreeland 2003: “By bringing in the IMF, governments gain political leverage - via conditionality - to push through unpopular policies. For certain constituencies, these policies dampen the effects of bad economic performance by redistributing income. But IMF programs doubly hurt others who are less well off: They lower growth and exacerbate income inequality.”

Take homes• Trade is “efficient”

• But there are winners & losers– Globalization winners – factor model: Abundant factor– Globalization losers – factor model: Scarce factor

– Globalization winners – sector model: Export-oriented sector– Globalization losers – sector model: Import-competing sector

• Political institutions may influence how we deal with losers

• Import-Substitution Industrialization

• Export-oriented industrialization

• International Institution – the IMF – can help break gridlock

• So, today’s take-home points in 3 words:

Factors, Sectors, Institutions

Thank youWE ARE GLOBAL GEORGETOWN!