Trade Diversion

NBER Working Paper No. 15628:

Micro-level data have had a profound influence on research in international trade over the last ten years. In many regards, this research agenda has been very successful. New stylized facts have been uncovered and new trade models have been developed to explain these facts. In this paper we investigate to which extent answers to new micro-level questions have affected answers to an old and central question in the field: How large are the gains from trade? A crude summary of our results is: “So far, not much.”

What they’re saying is:

Our analysis focuses on models featuring five basic assumptions: Dixit-Stiglitz preferences, one factor of production, linear cost functions, complete specialization, and iceberg trade costs… A common estimator of the gains from trade… only depends on the value of two aggregate statistics: (i) the share of expenditure on domestic goods, which is equal to one minus the import penetration ratio, and (ii) a gravity-based estimator of the elasticity of imports with respect to variable trade costs, which we refer to as the “trade elasticity.”… within that particular, but important class of models, the mapping between trade data and welfare is independent of the micro-level details of the model we use…

A direct corollary of our analysis under perfect competition is that two very well-known gravity models, Anderson (1979) and Eaton and Kortum (2002), have identical welfare implications. In Anderson (1979), like in any other “Armington” model, there are only con- sumption gains from trade, whereas there are both consumption and production gains from trade in Eaton and Kortum (2002). Nevertheless, our results imply that the gains from trade in these two models are the same: as we go from Anderson (1979) to Eaton and Kortum (2002), the appearance of production gains must be exactly compensated by a decline in consumption gains from trade.

I’ve tried to pull together some of the job market papers featuring trade theory and empirics. I neglect international finance and open economy macro papers here. Feel free to add more in the comments.

Saroj Bhattarai (Princeton) “Optimal Currency Denomination of Trade: Theory and Quantitative Exploration”

Lorenzo Caliendo (Chicago) “Estimates of the Trade and Welfare Effects of NAFTA”

Camila Campos (Yale) “Incomplete Exchange Rate Pass-Through and Extensive Margin of Adjustment”

Arpita Chatterjee (Princeton) “Why Do Similar Countries Choose Different Policies? Endogenous Comparative Advantage, and Welfare Gains”

John Dalton (Minnesota) “Explaining the Growth in Manufacturing Trade”

Swati Dhingra (Madison) “Trading Away Wide Brands for Cheap Brands”

Brian Kovak (Michigan) “Regional Labor Market Effects of Trade Policy: Evidence from Brazilian Liberalization”

Zhiyuan Li (UC Davis) “Task Offshoring and Organizational Form: Theory and Evidence from China”

Lin Lu (Minnesota) “Trade and Variety: The Effect of Within-Country Income Inequality”

Asier Mariscal (Chicago) “Global ownership patterns”

Carlos Noton (Berkeley) “Structural Estimation of Price Adjustment Costs in the European Car Market”

Soonhee Park (Michigan) “International Fragmentation and Work Effort: Networks, Loyalty and Wages”

Ana Maria Santacreu (NYU) “Innovation Diffusion and Trade: Theory and Measurement”

Gloria Sheu (Harvard) “Price, Quality, and Variety: Measuring the Gains from Trade in Differentiated Products”

Victor Shlychkov (Columbia) “Organizational Forms of Importing Firms in U.S. Manufacturing”

Yoichi Sugita (Columbia) “Matching, Quality, and Comparative Advantage: A Unified Theory of Heterogeneous Firm Trade”

John Tang (Berkeley) “Pollution Havens and the Trade in Toxic Chemicals: Evidence from U.S. Trade Flows”

Marc Teignier-Baque (Chicago) “The Role of Trade in Structural Transformation”

Jade Vichyanond (Princeton) “Intellectual Property Protection and Patterns of Trade”

Kevin Wiseman (Minnesota) “Location, productivity, and trade“

Last week, I attended the Intelligence Squared debate on Buy American/Hire American provisions. It pitted Jagdish Bhagwati, Doug Irwin, and Susan Schwab against Leo Gerard, Rick MacArthur, and Jeff Madrick; the transcript is available online (pdf).

Rick MacArthur, who wrote The Selling of Free Trade and called his debate team “the protectionist side”, opened his speech with an attack on the credibility of international economics. He said Thomas Carlyle labeled economics “the dismal science” because it was not a hard science (not even close), and that free traders cling to David Ricardo “with Marxist fervor.” He then quoted a paragraph from Paul Krugman’s Geography and Trade (1991), which says:

[T]he tendency of international economists to turn a blind eye to the fact that countries both occupy and exist in space — a tendency so deeply entrenched that we rarely even realize we are doing it — has, I would submit, had some serious costs. These lie not so much in lack of realism — all economic analysis is more or less unrealistic — as in the exclusion of important issues and, above all, important sources of evidence.

It’s immediately obvious to anyone familiar with Krugman’s body of work or who notices the link between the phrase “occupy and exist in space” and the word Geography in the title that MacArthur has pulled this quotation out of context. Paul Krugman would likely be one of the last people on earth to say that trade theorists don’t have useful contributions to make. In fact, he says so on the very same page of Geography and Trade:

There is nothing wrong with simplifying assumptions — on the contrary, it is only through strategic simplification that we can hope to make any sense of the buzzing complexity of the real world. The particular simplifying assumptions of conventional trade theory have led to an impressive and very useful intellectual construct. For some purposes it does no harm to ignore the fact that countries are not points and that some pairs of countries are much closer than others — that California is farther from New York than any place in the European Community is from any place else, or that London and Paris are much closer to each other than are New York and Chicago, or for that matter that Canada is essentially closer to the United States than it is to itself.

Yet the tendency of international economists to turn a blind eye to the fact that countries both occupy and exist in space — a tendency so deeply entrenched that we rarely even realize we are doing it — has, I would submit, had some serious costs. These lie not so much in lack of realism — all economic analysis is more or less unrealistic — as in the exclusion of important issues and, above all, important sources of evidence. As I hope I will be able to show, one of the best way to understand how the international economy works is to start by looking at what happens inside nations. If we want to understand difference in national growth rates, a good place to start is by examining differences in regional growth; if we want to understand international specialization, a good place to start is with local specialization. The data will be better and pose fewer problems of compatibility, and the underlying economic forces will be less distorted by government policies.

No intellectually honest person would claim that these paragraphs are ammunition for protectionists against unscientific trade theory. Shame on whomever provided the quotation to MacArthur — he’s been using it out of context for almost a decade now.

In “Trade, Tastes and Nutrition in India“, David Atkin introduces habits in consumption into a specific factors model of agricultural trade. If a country starts in autarky, then people become habituated to consuming the food produced by their abundant factors. This correlation of tastes and endowments means that when the economy opens to trade, the relative price of that good (for which autarkic consumers developed a habit) will rise. This reduces the consumption of food nutrients in the short-run compared to the habit-free case, as consumers don’t shift over to newly cheap imported foods as quickly as assumed.

Atkin doesn’t focus much on welfare comparisons, which are difficult in such a dynamic, habit-formation context; rather, he’s concerned with nutritional intake. He argues that nutrition matters – policymakers do care, nutrition impacts growth potential, and childhood malnutrition can have persistent long-run effects.

Atkin’s empirical testing ground is India, which has internal agricultural markets that are not very integrated. There are high transport costs, poor infrastructure, and state governments set agricultural policy, including production subsidies and tariffs on agricultural imports from other states.

I examine the predictions of this model of trade with habit formation using household survey data from India, where internal agricultural trade remains highly restricted. I identify tastes with the unexplained regional variation in household demand for agricultural products and find that regional tastes favor food crops that are well-suited to local agro-climatic conditions. I predict that the liberalization of internal agriculture trade in India will generate short-run caloric losses unless income gains from trade are relatively large, and that there would be no such losses if tastes were identical across the country. I also examine the consumption patterns of inter-state migrants, and find that they consume fewer calories for a given level of food spending than otherwise similar consumers. This effect only disappears two generations after migration, as tastes adjust to local prices. These findings, which reflect the higher prices of preferred origin-state goods in the migrant’s destination state, further corroborate the assumptions of my model.

In a 1996 article, William Milberg surveyed all international trade articles appearing in the AER, JPE, RES, and JIE from 1988 to 1992. He described two notable shortcomings:

Of articles containing no policy conclusions, 55.9 per cent included empirical studies. Of articles with policy relevance, only 16.1 per cent had empirical content. This is precisely the opposite of the expectation that policy-relevant research will tend to be grounded on empirical support, and that when such relevance is not at stake, empirical support will be less important. According to the survey, empirical analysis is often used to explore positive issues, whereas policy-related issues are most often analyzed using purely theoretical arguments…

[I]n a field where writing structure and even methodology are otherwise extremely uniform, the rhetoric of policy relevance is diverse, flexible and unrigorous. Paradigmatic convention seems not to dictate this aspect of the discourse. Norms of systematic and logical analysis break down precisely where the most is at stake in economic analysis – the legitimacy of its policy conclusions.

It’d be fascinating to see such an analysis of the recent literature.

Hat tip: Matthew Eagleton-Pierce.

Krugman, Paul 2009. “The Increasing Returns Revolution in Trade and Geography.” American Economic Review, 99(3): 561–71.

Opp, Sonnenschein, and Tombazos, forthcoming in the JIE:

We demonstrate that Rybczynski’s classic comparative statics can be reversed in a Heckscher-Ohlin world when preferences in each country favor the exported commodity. This taste bias has empirical support. An increase in the endowment of a factor of production can lead to an absolute curtailment in the production of the commodity using that factor intensively, and an absolute expansion of the commodity using relatively little of the same factor. This outcome – which we call “Reverse Rybczynski” – implies immiserizing factor growth. We present a simple analytical example that delivers this result with unique pre- and post-growth equilibria. In this example, production occurs within the cone of diversification, such that factor price equalization holds. We also provide general conditions that determine the sign of Rybczynski’s comparative statics.

Marc Melitz nicely summarizes the empirical and theoretical literature on “international trade and heterogeneous firms” for the New Palgrave Dictionary of Economics, 2nd Edition.

Oxford’s Alberto Behar and Ben Nelson are working to build a really rigorous trade gravity model. They combine Anderson and van Wincoop’s general equilibrium multilateral resistance approach with Helpman, Melitz, and Rubinstein’s emphasis on firm heterogeneity and the extensive margin.

We argue that one needs to take both AvW and HMR’s findings into account, otherwise interpretation of the effects of trade frictions will be misleading. We therefore unite these two strands of the literature. We derive a theoretically grounded gravity equation and then extend a method of approximating MR [multilateral resistance] terms, developed by Baier and Bergstrand (2009), to the case of firm heterogeneity…

For all our observations, traditional linear estimates bias downwards the effect of observable trade barriers on country-level trade flows. This difference, rather than the firm-level bias in the opposite direction highlighted by HMR, is arguably more relevant for policy…

Consistent with AvW’s “Implication 1″, larger countries have larger firm-level elasticities of bilateral trade in response to multilateral changes in trade costs. However we show that, once firm entry into trade is accounted for, this is no longer unambiguously true in theory for overall elasticities at the country level. Moreover, on balance we find a negative correlation in the data between country size and bilateral trade elasticities once changes in the extensive margin are accounted for.