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
Capital abundant ???
Labor abundant
Authoritarian
Back to 2 factors (ignoring collective action problem)
Democracy
Capital abundant Labor loses from
trade but has
political power
protectionism
Labor abundant ???
Authoritarian
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
Back to 2 factors (ignoring collective action problem)
Democracy
Capital abundant Labor loses from
trade but has
political power
protectionism
Labor abundant Labor wins from
trade & has
political power 
free trade
Authoritarian
Capital wins from
trade & has
political power
free trade
???
Back to 2 factors (ignoring collective action problem)
Democracy
Capital abundant Labor loses from
trade but has
political power
protectionism
Labor abundant Labor wins from
trade & has
political power 
free trade
Authoritarian
Capital 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
Pro-trade


Peron in
Argentina,


Vargas in
Brazil
Pro-trade
Pro-trade


Examples:
CLASS
CONFLICT
Anti-trade
URBAN-RURAL
CONFLICT
Anti-trade

URBAN-RURAL
CONFLICT
Anti-trade
CLASS
Anti-tradeCONFLICT

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 factorprice-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, furnituremakers, 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 capitalintensive industries both gain from trade
• The export-oriented SECTOR
• Capital AND labor employed in laborintensive 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=ZWOikcNwsM&feature=related
Summarizing factors & sectors
• Factor model (abundant factor wins, scarce
loses)
• Sector model (both factors in an abundantfactor-sector win; both factors in a scarcefactor-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
Pro-trade


Peron in
Argentina,


Vargas in
Brazil
Pro-trade
Pro-trade


Examples:
CLASS
CONFLICT
Anti-trade
URBAN-RURAL
CONFLICT
Anti-trade

URBAN-RURAL
CONFLICT
Anti-trade
CLASS
Anti-tradeCONFLICT

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
80%
% imported
60%
60%
35%
40%
20%
10%
0%
1949
1959
Year
1964
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)
Why was it hard to break free of ISI?
Pro-trade

URBAN-RURAL
CONFLICT
Anti-trade

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 savings
2. Appropriately valued exchange rates
– Helps promote exports
3. 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
Structural
Adjustment…
or…
• 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
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?)
How does bringing in the IMF help
push through economic reform?
Figure 1: The logic of bringing in the IMF
Payoff to veto player
Accept
-1 (change policy)
Veto
player
Without
the IMF
Reject
0 (maintain the status quo)
Executive
With the IMF
Accept
Veto
player
Reject
-1 (change policy)
+ loan
-r (reject the IMF)
• 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 you
WE ARE GLOBAL GEORGETOWN!