GGD

Question 1

Trade liberalization: The IMF economist Petia Topolova studied the impact of trade liberalization on poverty and average consumption in India during the 1990s. She identifies the effect by linking poverty and consumption outcomes to the ‘intensity’ of the liberalization. This intensity will have been different across different districts depending on the sectoral composition of the economy. The main equation she estimates is (see attached).

where y denotes the outcome variable (poverty or consumption), ‘Tariff’ is the district-specific measure for overall tariffs, ‘Post’ is a time dummy, denoting a common trend in districts, delta is a district fixed effect and epsilon the error term of the regression. d is the index for district, t=0 refers to data from 1987 and t=1 to data from 1997.

• Contrast this approach to measuring the impact of liberalization on poverty to the one proposed by Winters, McCulloch and McKay (Trade liberalization and poverty: the evidence so far, discussed during the first lecture).
• Topalova acknowledges that estimating the regression equation could be compromised by endogeneity of the variable, which is essentially an employment weighted average of individual product/sector tariffs. How could such endogeneity arise? In other words, how could the residual be correlated to the regressors?
• Topalova’s findings suggest that poverty declined less between 1987 and 1997 in districts with less trade protection. Referring to the Winters et al. article mentioned above, can you think of a (at least one) plausible scenario why trade liberalization has not benefited the poor?

Answer 1

• Note on Topalova paper:
  
  • looks at TL and poverty by exploiting exogenous impact of TradecReform Act which led to different exposure to foreign trade and product mix and thus cross-district variation in intensity of TL. Use tariffs as a measure of TL. However tariffs are correlated with poverty levels. Solve this by instrumenting tariffs using employment weighted indictor for tradable goods only. Finds that poverty INCREASES with TL. Mainly due to lack of labour mobility between districts.
  • looks at output of firms in a district. Obviously, they find that firms that are in districts that lose protection lose output. However, paper 2 identifies that liberalization reduces both output and input prices, and so it’s the net effect of the two that determines whether profits go up or down. By only looking at output factors, they ignore the reduction of input prices.
• WMcMcK would be very skeptical of Topalova’s approach. They argue that there are many factors affecting poverty besides TL and that the impact of TL cannot be established experimentally (for obvious reasons). Instead they favour an approach where individual ‘channels’ from TL to poverty are studied. Note that Topalova’s estimated impact involves the impact, direct and indirect, along all channels.
• Foreign exposure of districts is likely to be correlated to growth rates, e.g. with almost autarkic districts being slow growers. These districts would also experience low TL intensity creating an artifical correlation between growth and TL.
• Many answers possible and approved.

Question 2

Standards: Consider the following case: Domestic production of a certain tradable good leads to purely domestic pollution. The pollution can be avoided but that adds an extra C to unit costs. Assume that the welfare gain from avoided pollution can be quantified to be at least C per unit produced. Therefore the government decides to make the clean production process compulsory for producers. Producers complain that this decision leads to a loss of competitiveness and they lobby for a tariff of C per unit on imports of the good to restore a level playing field. Show (using an appropriate graph) that this is a bad idea from a social welfare point of view.

Answer 2

See graph in lecture slides. [The graph must be readable and make sense.] The main point is that (compared to the case of only a pollution charge on output) the loss of consumer surplus is not compensated by the gain in producer surplus; compared to no policy at all the combination of a pollution tax and import tariff could lead to a loss of CS that is greater than the gain from less pollution.

Question 3

Standards: Discuss the merits of harmonization of standards from the points of view of welfare theory and political economy.

Answer 3

Welfare theory: because different circumstances, preferences and resources one would expect a first best solution to involve different standards for different countries, even in the case of global externalitites. Political economy: between countries it is easier to agree on common standards and harmonized standards are likely to be better than no standard setting at all: a typical case of a second best solution.

Question 4

Standards: What is the best combination of standards and trade policy to address local pollution, according to Bhagwati and Srinivasan? Will such a policy always lead to an increase in welfare? Why / why not?

Answer 4

Free trade and fully internalized pollution costs, e.g. using pollution tax. For a single small country this increases welfare. On the other hand, if all countries do this at the same time it could be welfare diminishing for importing countries.

Question 5

Globalization: In their article on globalization and labour’s share in advanced countries Jaumotte and Tytell mention three trends that can affect the wage share in GDP: Globalization, technological progress, policy.

• For each of these trends, explain how globalization affects the share of wages in GDP in advanced countries, possibly distinguishing between skilled and unskilled labour.
• Jaumotte and Tytell base their regression equations on a translog production technology. Why couldn’t they have used the much simpler Cobb-Douglas technology?
• To assess the impact of technology on the wage share Jaumotte and Tytell use a quadratic function of ICT capital in their regressions. Why did they anticipate a nonlinear impact of ICT capital on the wage share?

Answer 5

• Globalization: Effect of TL on factor payments; immigration; outsourcing. Technical progress: biased technical progress can favour certain production factors, e.g. computer technology is favourable for skilled labour. Policy: labour market policies affect employment and wages directly
• They are interested in changes of factor shares. With a Cobb-Douglas production function these factor shares are constant, so estimating the parameters of a CD function is pointless for their research question.
• J&T anticipate that the impact of ICT involves a learning effect: as more people use ICT in their work the impact is likely to rise. The learning effect can be mimicked by an (increasing) quadratic term. [Note: answers that essentially say that nonlinear is more general than linear have not been counted as correct. Mentioning the learning effect is required for full score.]

Question 6

Trade shocks, resources & civil war: The idea of a “Resource Curse” was given empirical support in a series of empirical cross-country analyses by Sachs and Warner during the 1990s and early 2000s. These documented a negative relationship between natural resource availability in countries and their subsequent economic growth. According to van der Ploeg and Poelhekke (2009) the approach employed by Sachs and Warner ignores a fundamental determinant of economic growth, namely volatility. How are natural resources, volatility and economic growth related according to the van der Ploeg and Poelhekke study (2009)?

Answer 6

Van der Ploeg and Poelhekke show that natural resource dependence is positively associated with GDP growth directly, but strongly and positively associated with volatility of growth which in turn is negatively associated with growth. Thus the net effect of natural resource dependence is negative.

Volatility hampers growth:

• Volatility could result in liquidity constraints for firms, driving reduced innovation. Especially if financial institutions are poorly developed; with complete financial markets long-term investment is counter-cyclical, mitigating volatility.
• Resource bonanza leads to false sense of security in good times
• Irreversible investments could lead to inefficient use of resources in downturns.
• Risk averse agents, in the face of volatility, may make savings and investment decisions that lower subsequent growth. This makes it ore difficult to identify directly volatility.
• Could also have a positive impact on growth with more precautionary saving

Question 7

Trade shocks, resources & civil war: Elbers, Gunning and Kinsey (2007) discuss the possibility of shocks having an ex-post effect on incomes, but also affecting saving and investment ex-ante. In what way does this discussion bear on the van der Ploeg and Poelhekke results?

Answer 7

The argument of Elbers, Gunning and Kinsey is that because volatility reduces the welfare of risk-averse agents, these may seek to avoid exposure to volatility by making saving and investment decisions ex-ante that lead to lower subsequent growth. Thus the kind of indicator of volatility applied by van der Ploeg and Poelhekke may not capture well countries’ actual exposure to volatility

Question 8

Trade shocks, resources & civil war: What is the concern that Brunnschweiler and Bulte (2008) raise with respect to the standard Sachs and Warner analysis?

Answer 8

Brunnschweiler and Bulte (2008) critique the measure of natural resource abundance used in the literature (natural resource exports as a percentage of GDP) arguing that this is a measure of natural resource dependence. The show that when a more credible measure of natural resource abundance is constructed, its relationship with growth is positive and significant.

Question 9

Trade shocks, resources & civil war: Collier and Hoeffler (2004) study the determinants of the outbreak of civil war and highlight the distinction between “opportunity”-related determinants and those that are related to “grievance”. Explain why “low income” could, in principle, be interpreted as both an opportunity-related driver of civil war outbreak, and a grievance-related determinant. What argument do Collier and Hoeffler employ to justify interpreting low income as an opportunity-related determinant in their analysis?

Answer 9

“low income” can be interpreted as a grievance indicator in that it could feed social alienation, resentment vis-à-vis the well off, etc. It can also capture the opportunity cost of engaging in civil war and this be interpreted as an opportunity indicator. Collier and Hoeffler argue in their study that it is probably better seen as an opportunity indicator because income inequality was not found to be significant in their grievance model. (Income inequality would be thought to proxy grievance in a similar way as low income).

Question 10

Institutions & international finance: In their review of policy approaches to deal with the problem of Odious debt, Doemeland et al (2009) warn that encouraging/facilitating debt repudiation could prompt new costs. Provide an example of such costs.

Answer 10

• Important, learn new: Regimes declared odious will be more likely to default on earlier, legitimate, debt. Creditors adhering to framework will be punished with defaults on loans to earlier predecessor regimes, while creditors lending to odious regimes are likely to be repaid (as long as odious regime remains in power).
• Doemeland et al. argue that a likely consequence of encouraging debt repudiation would be to raise the cost of loans for all borrowers. This would be because of the uncertainty lenders felt that at least some of their loans would not get paid, and the need to cover themselves against that eventuality. It is also likely that lenders would want to cover the likely higher costs of litigation through higher interest rates.

Question 11

Institutions & international finance: Describe one of the key challenges with implementing an ex-ante Odious regime policy, such as was outlined by Jayachandran and Kremer (2006).

Answer 11

A particular challenge in the Jayachandran and Kremer proposal is the designation of a body that would be able and credible to designate particular regimes as “odious”. There would likely be many political-economy roadblocks to setting up such an institution.

Question 12

Institutions & international finance: Explain why Rodrik, Subramanian and Trebbi (2009), in their study of the determinants of income differences between countries, argue that a good instrument is not necessarily a good theory. Use the settler mortality instrument introduced by Acemoglu et al (2001), as an example.

Answer 12

Settler mortality in the distant past was found to be a good proxy for present day institutional quality, and yet unlikely to be shaped by present day income, nor correlated with other determinants of present day income levels. Thus it is a good instrument. However, as a general point institutional quality cannot be seen to be driven in a fundamental way by the mortality rates of settlers. After all, there are many countries that were never colonized, and these countries reveal as great heterogeneity in their institutional quality as formerly colonized countries.

Question 13

Institutions & international finance: Rodrik et al. emphasize the centrality of institutions in understanding differences in income across countries. Does this imply that geography plays no role?

Answer 13

The Rodrik analysis reveals that while geography does not appear to be directly correlated with income levels, it is indirectly correlated with institutional quality which in turn is strongly correlated with income levels. Thus geography does play an important role, but an indirect one.

Question 14

Migration & Global inequality: Milanovic (2012) drew attention to the “Elephant Curve” underpinning the evolution of global inequality between 1988 and 2008. What is this curve and what does it indicate about the winners and losers from economic growth during these two decades?

Answer 14

The Elephant Curve is a growth incidence curve for the world as a whole, documenting the growth rates for all percentiles of the income distribution. The curve shows that the biggest winners in terms of growth, between 1988 and 2008, have been the riches one percent of the world population and the middle classes. The losers have been the bottom 5% and the relatively rich (between 75-95%). This latter group in fact comprises the lower middle classes in the rich countries of the world.

Question 15

Migration & global inequality: In what way does the decomposition of global inequality by Milanovic (2012) help us understand why international migration pressures are so high?

Answer 15

Decomposing global inequality into a within-country and between-country component reveals that by far the largest contribution to global inequality comes from average income differences between countries. Thus a person born in a poor country is unlikely to be able to climb very far up the global income ladder if he stays within his own country. The only way to make further progress is to move to a richer country (migrate).

Question 16

Migration & global inequality: Williamson’s 2004 review of world mass migration during the 19^th and 20^th centuries suggests that across the two global centuries of migration, there was a fairly similar impact of migration on host-country inequality. How was inequality affected by migration, and what was the likely mechanism driving this impact?

Answer 16

In both migration centuries host-country inequality generally increased as migration. This is because migrants are generally low-skilled and compete with the low-skilled host-country population. This puts downward pressure on the wages for the unskilled, as well as possibly increasing unemployment amongst the unskilled. Skilled workers by contrast become relatively scarce as the numbers of unskilled workers swell, and thus see their wages rise. These forces generally act to increase earnings inequality.

Question 17

Migration & global inequality: How you think that the Winters et al (2003) proposal to liberalize the temporary movement of people would affect host-country inequality?

Answer 17

The Winters (2003) proposal builds in an explicit provision to ensure that migrants are temporary and therefore do not represent long-term competition for local workers. Moreover the proposal indicates that wages paid to the temporary workers should be equal to those currently received by local workers – with the financial incentive to recruit such temporary workers coming from the fact that employers might be spared the requirement to pay certain benefits, such as pension contributions. Combined these measures should have the effect of dampening the upward pressure on host-country income inequality.

More generally, effect on economy:

• Could lead to large increases in welfare.
• Aging and more educated populations means more space for new lower skilled workers.
• Could work through subcontracting schemes tied to specific projects so that migrants go home upon completion.
• Employers would pay equal wages to immigrants to dampen negative effect on native wages and to dampen effect on inequality.

Question 18

Trade shocks, resources & civil war: The Dutch Disease model links resource abundance to economic performance. The canonical model demonstrates that as resources flow into a growing sector (e.g. following a natural resource discovery) a country’s currency appreciates and other exporting sectors become less competitive. Explain why this model does not fully capture the idea of a natural resources acting as a “curse” on a country’s growth.

Answer 18

The Dutch Disease model is static and not specifically focused on growth. In the canonical Dutch Disease model, aggregate welfare increases as a result of the increased price of the exported good, even if other exporting sectors decline as a result of the currency appreciation.

However, model is static and doesn’t explain growth as rising commodity price will increase growth in resource sector more than currency appreciation decreases growth in non-resource exporting sector.

• Appreciation of real exchange rate slows down growth of non-resource sector, loss in learning by doing which leads to lower total factor produtivity and therefore lower growth.
• Dependence on natural resource rents may lead to rent seeking and or less dependence on taxes and therefore less pressure for political reform

Question 19

Trade shocks, resources & civil war: What is the mechanism proposed by Sachs and Warner, 1995, and Matsuyama, 1992 (as reported in van der Ploeg and Poelhekke, 2009 and Frankel, 2010, respectively) whereby the Dutch Disease story can be extended to posit a relationship between natural resources and growth?

Answer 19

Windfall resource revenues lead to an appreciation of the real exchange rate and a decline of the non-resource export sectors. The leads to loss in learning-by-doing in the non-resource export sectors, resulting in a fall in total factor productivity growth.

Question 20

Trade shocks, resources & civil war: Van der Ploeg and Poelhekke (2009) assemble new and better data and are able to reproduce the key empirical finding of Sachs and Warner. Briefly describe this finding and how van der Ploeg and Poelhekke (2009) throw this finding into question. (3 points)

Answer 20

Sachs and Warner document a negative relationship between resource exports as a share of GDP and subsequent growth. They dub this the “resource curse”. Van der Ploeg and Poekhekke (2009) suggest that in fact, natural resources do not have a direct and significant, negative, effect on growth. Rather, natural resources are associated with greater volatility of growth, and it is this volatility, in turn, that has a strong negative effect on subsequent growth. They argue, thus, that Sachs and Warner fail to properly capture the line of transmission from natural resource dependence to economic growth.

Question 21

Trade shocks, resources & civil war: Collier and Hoeffler (2004) attempt to arbitrate between rival theories aiming to explain the outbreak of civil war. Their analysis appears to find greater support for the opportunity (“greed”) driver than for the motive (“grievance”) driver. Explain why the possibility that grievances are misperceived could undermine the neat distinction between the two rival explanations.

Answer 21

If grievances are misperceived then there is always a motive for fighting. The key factor, then, will be the viability of conflict. Viability and opportunity are close to being observationally equivalent. Thus it is possible that conflict will break out, notionally as a result of opportunity, but actually because of grievances that happen to be misperceived.

Question 22

Institutions & international finance: Domeland, Gil Sander and Primo Braga (2009) describe a four-way classification of policy approaches to deal with the issue of odious debt. Briefly describe the approaches in turn. In what way do legitimate borrowers suffer from the pursuit of such odious debt policies?

Answer 22

Policy approaches can be divided into ex-post and ex-ante odious regime policies, and ex-post and ex-ante odious loans policies. The ex-post odious regime policy declares that debts incurred by an odious regime do not require payment. With the ex-ante regime policy, and international body determines that a regime is odious and then declares that debts incurred subsequently will not be enforceable. The ex-post odious loans policy involves auditing individual loans that have been taken and declaring that those deemed illegitimate need not be repaid. With the ex-ante odious loan policy creditors do due-diligence on prospective loans, and only loans that did not meet pre-defined standards ex-ante could be repudiated. A common consequence of all policy approaches is a general rise in the cost of borrowing because of the greater uncertainty, legal costs, etc.

Question 23

Insititutions & international finance: Ginsberg and Ulen (2007) draw attention to the existence of the “odious creditor”. What do they have in mind with this classification? In what way do such creditors discourage the emergence of an odious debt doctrine?

Answer 23

The odious creditor is a state that has no particular interest in advancing democracy or the specific interests of the citizens in other countries, but that is a significant lender to other states. If the odious creditor is happy to extend credit to countries that would likely be designated as odious regimes, then the odious debt policy approaches described in Domeland et al (2009) are likely to become ineffectual.

Question 24

Institutions & international finance: Rodrik et al (2004) attempt to understand why there exist such enormous differences in per capita income across countries. They focus on three “deep” drivers of economic performance: geography, international trade and institutions. What is the proxy for each of the respective drivers that Rodrik et al (2004) employ in their regression? Why are they unable to estimate a simple OLS model of income on these three proxies?

Answer 24

Rodrik et al (2004) employ distance from the equator, flows of trade, and perception-based indicators of the strength of rule of law, are used to proxy, respectively geography, international trade and institutions. A simple OLS model is inappropriate because both flows of trade, and rule of law, are likely to be endogenous (influenced by income level).

Question 25

Institutions & international finance: From their more robust IV-based analysis Rodrik et al (2004) find that geography is generally negatively (albeit not always significantly) related to income. This is direct contrast to the OLS-based findings where distance from the equator is found to be strongly and positively associated with higher incomes. Explain why Rodrik et al (2004) maintain however, that geography remains a very important underlying determinant of income.

Answer 25

In the second stage models, geography is not found to be significant (and often negatively related) as determinant of income. However, Rodrik et al find that geography is an important determinant of institutional quality, and institutions are in turn highly significantly related to income. Thus geography exercises an important, indirect, impact on income.

Question 26

Migration & global inequality: Williamson (2004) suggests that international migration is associated with rising inequality in the host countries. Milanovic (2012) argues that the increase in global inequality between the late 19^th and late 20^th centuries has led to increased pressure to migrate. Briefly elaborate on these two authors’ arguments.

Answer 26

Williamson: international migration is generally associated with a growing wedge between wages earned by unskilled migrants and unskilled domestic workers and those received by skilled domestic workers. This is associated with rising inequality.

Milanovic: global inequality has been rising and is disproportionately due to location. A global citizen’s living standard is largely affected by his country of birth. Given the importance of location, international migration emerges as one of the key means for an individual to significantly raise his living standard.

Question 27

Migration & global inequality: Winters et al (2003) argue that allowing the temporary movement of workers could yield significant efficiency gains. How does the Winters et al (2003) proposal address the political sensitivities of permitting the in-migration of unskilled workers from abroad?

Answer 27

The Winters et al (2003) proposal focuses on the temporary migration of workers who are employed as part of the implementation of specific projects and are expected to return to their home country following completion of those projects. The typical expectation would be for the earnings received by these temporary workers to be lower than those received by local unskilled workers (via, for example, the elimination of a component aimed at covering social security contributions). But since the migrants’ employment is clearly linked to the life-time of a specific project, the proposal can be sold as temporary and thereby as less politically sensitive.

Question 28

Migration & global inequality: What is the association posited by Hartmann et al (2017) between a country’s level of income inequality and the complexity of its productive structures? Provide one possible reason for this.

Answer 28

Hartmann et al (2017) suggest that economic complexity is associated with lower inequality. Possible reasons include: that the mix of products produced by a country constrains the occupational choices, learning opportunities and bargaining power of workers; that complexity and diversity of products are a good proxy for the knowledge and knowhow in an economy not captured by conventional human capital measures; that productive structures can proxy social capital and health of institutions (complex products require social and professional networks); economies based on the exports of a few natural resources are likely to exhibit political structures prone to capture.

Question 29

Standards: Consider the following case: domestic production of a certain tradable good leads to purely domestic pollution, say one ‘pollution unit’ per unit of output. This pollution can be avoided but that adds an extra C to unit costs. Assume that the welfare gain from avoided pollution can be quantified to be at least C per pollution unit. There is no domestic demand for the good: all the output is exported at a given world market price p_w and export demand is fully elastic at that price. The government decides to make the clean production process compulsory for producers. Show (e.g. by using an appropriate graph) that this leads to an overall welfare increase.

Answer 29

See the graph. The welfare increase to consumers from reduced pollution is at least Cq₀, the cost of undoing original pollution, which is equal to area A+B. The loss of producer surplus is area A so that the overall increase in welfare is at least B.

Question 30

Standards: Producers complain that the no-pollution standard leads to a loss of competitiveness and they lobby for a tariff of per unit on imports of the good to restore a level playing field. The government explains that this is a crazy idea. Why?

Answer 30

There is no import of the good, so the tariff will change nothing.

Question 31

Standards: Once the producers understand their mistake they now argue for a government subsidy of per unit of output in order to maintain competitiveness. Discuss the merits of this plan: will it increase social welfare? Is it better than the government plan?

Answer 31

The increase in welfare will now still positive, given the assumptions made in the example. But production of the good will be too high: it will stay at q₀ rather than shrink to q_{<span>1</span>}, creating a dead-weight loss.

Question 32

Standards: What is the best combination of standards and trade policy to address pollution that crosses borders, according to Bhagwati and Srinivasan? Will such a policy lead to harmonization of standards? Why / why not?

Answer 32

Each nation should internalize global pollution cost by domestic policy, combined with free trade. In a first best optimum this would in all likelihood lead to different standards but in practice political economy considerations will favour harmonized standards setting across nations, perhaps with exceptions for developing countries.

Question 33

Trade liberalization: In his overview article on the decoupling of emerging economies (EEs) from advanced economies (AEs) Antonio Pesce raises the question whether decoupling and globalization can co-exist. Pesce discusses the possible impact on decoupling of (i) stronger trade linkages, (ii) stronger financial linkages, and (iii) trends in fiscal policy in EEs and AEs. He concludes that there is no reason to expect that these would always lead to increased (or decreased) coupling: it would depend on particulars.

For each of the three trends mentioned (trade linkages, financial linkages, fiscal policy trends) discuss if (and if so, how) they could lead to increased, and to decreased coupling.

Note: For the purpose of this exam question you can loosely define decoupling as reduced co-movement of business cycles or the increased resilience to external shocks.

Answer 33

• Stronger trade linkages: if industry shocks are important in driving economic cycles, then the co-movement of economic cycles is expected to decrease when stronger trade linkages are associated with inter-industry specialization, whereas (ii) co-movement is expected to increase when stronger trade linkages are associated with intra-industry specialization.
• Financial linkages: (also p 609). (i)Foreign direct investments, contagious effects of shocks could increase synchronization, on the other hand (ii) financial openness could decrease the co-movement of economic cycles by facilitating inter-industry production specialization through the easy reallocation of capital,
• Fiscal policy trends: In the (i) AEs fiscal policy tends to be counter-cyclical while in (ii) EEs it tends to be pro-cyclical, perhaps due to credit constraints and incomplete capital markets. (i+ii) Across AEs and EEs the net effect would be to reduce the co-movement of cycles

Question 34

Globalization: To explain the growing wage gap between higher-skilled and lower-skilled workers in advanced economies economists often mention the Samuelson-Stolper theorem. Briefly explain how this theorem could help explain growing wage inequality in advanced economies.

Answer 34

• Definition: A rise in the price of a good e.g. through trade will raise the price of the abundant factor and decrease the price of the scarce factor. Also applies to neutral technical progress. Thus with a skilled sector and unskilled sector, technical progress in the skilled sector will increase wages in the skilled sector relative to the unskilled sector, fueling wage inequality. In a country that trades both high and low skill intensive products, a rise in the price of the low skill product will lead to an increase in wages for low skilled workers relative to high skilled workers and vice versa when the price falls.
• S-S theory is applied here with the two factors skilled and unskilled labour. AEs being relatively abundant in skilled labour. When trade barriers between AEs and EEs are reduced S-S would expect real wages for skilled labour to increase and for unskilled labour to decrease

Question 35

Globalization: In his article on Globalization and Wage Inequality, Elhanan Helpman refers to several empirical studies showing that trends in several variables, both in advanced and developing economies, do not support the Samuelson-Stolper theory. Mention at least two of these trends and explain why they seem to contradict it.

Answer 35

(1) S-S would (for the same reason) predict the wage gap to decrease due to tariff reductions in EEs and DEs, which did not happen in practice; (2) S-S effect on wage gap in AEs would be driven by relative price increase of skill-intensive products, but there’s no evidence of such an increase in the 1980s (Leamer did find such price changes in the 1970s); (3) empirical research suggests that only 20% of wage gap in AEs can be explained by trade; (4) reallocation of skilled labour from low-skill to high-skill sectors did not take place

Question 36

Globalization: Many empirical studies try to assess the role of globalization (especially trade liberalization) in explaining wage inequality. Two other factors are often mentioned too. Which ones? Also, explain how they impact on wage inequality.

Answer 36

(1) Biased technological change that increases marginal productivity of skilled labour (much) more than of unskilled labour (e.g. IT revolution); (2) labour market policies that reduced the power of unions and affecting especially organized (mostly unskilled) labour

Question 37

Standards:

• In a small country domestic production of a certain tradable good leads to purely domestic pollution. The cost of cleaning the environment is 40 Euro per unit produced. Consumers’ dislike for the pollution is so big that they would be willing to pay up to 50 Euro per unit produced to undo the environmental damage. The world market price of the good is given since the country is small and has no effect on its price. The government wants to address pollution by means of a pollution tax per unit of output. What tax rate should it choose? Why?
• Continuing the previous question: demand for the good is higher than domestic production. To compensate for the loss of competitiveness producers argue for an import tax equal to the pollution tax. Do you agree with them or not? Why?
• How should environmental issues be addressed if pollution is not purely domestic?

Answer 37

• 40 Euro since this is sufficient to make firms clean up or pay for cleaning up out of the tax. Note: not 50 Euro since that would unnecessarily distort consumption
• This is a bad idea from a welfare point of view: the decrease in consumer surplus is larger than the increase in producer surplus
• Cross-border pollution requires international coordination

Question 38

Trade shocks, resources & civil war: While the canonical Dutch Disease model is static, Sachs and Warner (1995) build on this model to point to a link between natural resource dependence and economic growth. Provide a brief description of their line of reasoning.

Answer 38

Sachs and Warner suggest that appreciation of the real exchange rate, following the discovery and exploitation of natural resources, leads to a decline of non-resource export sectors. If this results in a substantial loss of learning-by-doing in the non-resource export sectors, then total factor productivity growth may fall.

Also: Natural resources may also invite rapacious rent seeking and thus hamper growth. Reduced need for tax revenue may lead to reduced pressure for political reform

Question 39

Trade shocks, resources & civil war: By building on the empirical approach suggested by Ramey and Ramey (1995), van der Ploeg and Poelhekke add a proxy for a country’s growth volatility to their empirical model of the relationship between economic growth and natural resource dependence. Does their volatility measure convincingly capture to what extent a given country is severely exposed to uncertainty and risk? Explain.

Answer 39

The volatility measure derived by van der Ploeg and Poelhekke (2009) is based on a country’s realized growth variability. However, in the face of considerable uncertainty countries may well pursue policies that minimize the volatility of growth – at the possible expense of the level of economic growth. To the extent that countries pursue such a strategy the volatility measure derived by van der Ploeg and Poelhekke may not successfully identify those countries that face the greatest uncertainty in their economic environment.

Question 40

Trade shocks, resources & civil war: In their study of the determinants of the outbreak of civil war, Collier and Hoeffler (2004) suggest that the size of a country’s diaspora could play a role. What is the empirical finding in the Collier and Hoeffler paper concerning this determinant and their interpretation of it?

Answer 40

The Collier and Hoeffler (2004) study suggests that the size of diaspora increases the likelihood of a civil war outbreak via its interaction with the indicator capturing time since previous conflict. The suggestion is that the financing that can be furnished by the diaspora may slow the depreciation of conflict-specific capital, so that the time since previous conflict becomes less strongly associated with a lower risk of conflict outbreak.

Question 41

Trade shocks, resources & civil war: Explain in what way the analysis by Brunnschweiler and Bulte (2008) casts doubt on a key finding in the Collier and Hoeffler (2004) paper.

Answer 41

Collier and Hoeffler suggest that natural resource availability reduces the opportunity cost of launching a civil war. They proxy natural resource availability with an indicator of natural resource dependence (natural resource exports/GDP). Brunnschweiler and Bulte (2008) suggest that a proper measure of natural resource abundance is more appropriate, and find that with such a variable the relationship with outbreak of civil war becomes negative – suggesting that the opportunity cost of civil war rises.

Question 42

Institutions & international finance: Although Rodrik et al (2004) study the determinants of international income differences, they claim that their analysis is pertinent also to understanding what drives economic growth. Describe briefly how they arrive at this claim and how their analysis speaks to our understanding of the determinants of growth

Answer 42

Rodrik et al (2004) argue that the proximate “drivers” of growth, such as accumulation of physical and human capital and technical change, may themselves be determined by the “deep” drivers of geography, international integration and institutions that they explore. Indeed, they explicitly examine the relationship between physical capital per worker, human capital per worker, and total factor productivity, and these ‘deep’ determinants. Consistent with their findings on the drivers of differences in income levels, they find that institutions appear to be most strongly associated with the growth drivers. In particular they find a very strong impact of institutions on physical capital availability.

Question 43

Institutions & international finance: Why would it be inappropriate to conclude that the strong explanatory power of historical settler mortality rates implies that comparative development can best be understood in terms of country’s colonial origins?

Answer 43

Settler mortality rates were found to be a good instrument for countries’ institutional strength. These rates were found to be strongly correlated with indicators of present-day rule of law, and yet are arguably unrelated in any independent way with present day income levels. However, as pointed out by Rodrik et al (2004) settler mortality rates are patently unable to explain patterns of income differences in countries that have never been colonized (e.g. Turkey, Ethiopia). Thus, instruments don’t make a theory.

Question 44

Institutions & international finance: The paper by Domeland et al (2009) indicates that in the early 1900s the US proved willing to intervene militarily in Latin American countries unable or unwilling to service their debts. In what way did this impact on new borrowing by those countries?

Answer 44

Domeland et al., suggest that because “gunboat diplomacy” reduced the risk of debt repudiation, lenders were willing to lower the financing costs of new lending to sovereign borrowers.

Question 45

Institutions & international finance: Explain why the existence of odious creditors would make implementation of an ex-ante odious regime proposal particularly difficult.

Answer 45

The ex-ante odious regime policy framework calls for an international body that will decide and designate countries as odious regimes. Any lending to such regimes, once they have been designated as such, will then not be deemed to recoverable by lenders if the successor government repudiates those loans. In the presence of odious creditors – countries that are willing to lend as a means to pursue ulterior objectives – it becomes difficult to see how a consensus can be built amongst lending nations that particular regimes should be designated as odious.

Question 46

Migration & global inequality: Text-book supply and demand analysis of the impact of migration on the receiving country identifies clear winners and losers from an inflow of migrants into a country. Illustrate, on the basis of this analysis, how a simple departure from the basic underlying assumptions of the canonical supply and demand model could generate an outcome where there are no losers. Given prevailing migration pressures is this outcome likely? Explain.

Answer 46

The canonical supply/demand illustration can be adapted by assuming that capital flows follows the flows of people. In other words it is assumed that the labor demand curve shifts out as the labor supply curve shifts out (illustrate). In the new equilibrium there is more employment at a wage rate that may be no lower than what prevailed earlier, and thus domestic workers are not worse off. Given that migration flows would put downward pressure on capital/labour ratios in the receiving country, this could raise the returns to capital and thereby induce inflows of capital, which in turn raises the demand for labour. Given however, that in the second century of mass migration the “quality” of migrants is lower than in the preceding century – indicating that the current migrants are poorer and less well educated, in relative terms, than in the preceding century of migration – it is unlikely that they will bring with them significant inflows of capital.

Question 47

Migration & global inequality: Explain why a non-quota policy favouring “family reunification” is less likely to encounter domestic resistance than other policies that might encourage migration.

Answer 47

Historically, particularly strong resistance to migration has come from unskilled native workers who compete with migrants in the labor market. Migrants coming in under the “family reunification” policy are generally dependents (women and children) who are less likely to compete with native workers.

Question 48

Migration & global inequality: Explain why Milanovic’s “concept 1” and “concept 2” measures of the evolution of global inequality in the interval between 1980 and 2000 fueled a debate between those who claimed to see evidence of “convergence” across countries and those who saw, rather, “divergence”.

Answer 48

Concept 1 inequality is a measure of global inequality based in which each the per capita income of each country enters into the calculation with the same weight. On the basis of this concept, global inequality was seen to be rising between 1980 and 2000, indicating that countries were diverging from each other over time. Concept 2 weights each country’s per capita income by its population – so that large countries such as China and India receive particularly large weight. Because China and, subsequently, India were growing particularly rapidly during this interval, global inequality was seen to fall on the basis of the concept – suggesting “convergence” across countries.

Question 49

Migration & global inequality: Branko Milanovic (2011,2012) suggests that inequality fuels migratory pressures. Williamson (2005) suggests that migration fuels inequality. Explain how these two perspectives are entirely compatible with one another.

Answer 49

Milanovic is referring to global inequality, and in particular to his analysis that suggests that the overwhelming driver of global inequality comes from differences across countries in their average income. He suggests that knowledge of a person’s country of citizenship is virtually sufficient to know where that person is located in the global income distribution. And a person seeking to change his position in this global income distribution will thus naturally look to change his geographic location. Williamson (2005) is discussing the impact of in-migration on the recipient country’s income distribution. He reports findings from model-based projections suggesting that immigration increases inequality, and notes as well that the demise of migration after WWI likely contributed to the levelling of inequality post WWII.

Question 50

Trade shocks, resources & civil war: While the van der Ploeg and Poelhekke (2009) study does not study the precise mechanisms through which volatility is thought to affect growth, they refer to a number of possible economic arguments. Provide an example of how volatility might be expected to lower growth as well as one suggesting how volatility could increase growth.

Answer 50

Volatility could be associated with liquidity constraints , driving reduced innovation ( Aghion et al) and therefore lowering growth. Bernanke (1983) suggests that investments may be irreversible, so that that in downturns resources are committed inefficiently, thereby reducing growth. On the other hand, volatility might induce additional saving for precautionary purposes, and this might stimulate growth.

Question 51

Trade shocks, resources & civil war: How does the van der Ploeg and Poelhekke (2009) analysis help us to understand why a country such as Norway might benefit from natural resource dependence, while for a country such as Zambia such dependence can be a curse?

Answer 51

Van der Ploeg and Poelhekke (2009) show that the level of financial development is negatively related to volatility. In a country, like Norway, with a high level of financial development, the fact that it is natural resource dependent thus translates less sharply into greater volatility. In this case the direct, positive, effect of natural resource dependence might outweigh the negative effect of volality on growth, resulting in an overall positive impact of natural resource dependence on growth.

Question 52

Trade shocks, resources & civil war: Explain why it may be problematic to interpret the ratio of primary product exports to GDP as a measure of natural resource availability.

Answer 52

Ratio of primary product exports to GDP is better seen as a measure of primary product dependence rather than a measure of natural resource abundance.

Question 53

Trade shocks, resources & civil war: The paper by Collier and Hoeffler distinguishes between two types of explanations for the outbreak of civil war: “greed” and “grievance”. Explain how they set out to assess the empirical validity of these rival theories. Indicate under which type economic inequality can be classified, and explain why.

Answer 53

Collier and Hoeffler estimate two sets of models: one where the specification attempts to reflect opportunity or “greed” reasons for starting a civil war; and a second set that attempts to capture “grievance” motives for launching a civil war. They include inequality amongst the grievance factors – arguing that with greater inequality there may be more calls for redistribution and lower social cohesion. The two models are then combined and it is found that one cannot reject that the combined model is preferred to either one of the abbreviated models. However, they demonstrate that very few of the drivers of civil war in the grievance model are statistically significant in either the abbreviated grievance model or the combined model, while the explanatory variables in the greed model generally do a good job of explaining the outbreak of civil war. They conclude therefore that the opportunity factors are the more important explanatory variables.

Question 54

Institutions & international finance: Explain why Rodrik et al. argue that a good instrument is not necessarily a good theory. Use the Acemoglu et al (2001) instrument for institutions as an example.

Answer 54

Acemoglu et al (2001) propose using settler mortality rates as an instrument for countries’ institutional strength. These rates were found to be strongly correlated with indicators of present-day rule of law, and yet are arguably unrelated in any independent way with present day income levels. However, as pointed out by Rodrik et al (2004) settler mortality rates are patently unable to explain patterns of income differences in countries that have never been colonized (e.g. Turkey, Ethiopia). Thus, instruments don’t make a theory.

Question 55

Institutions & international finance: Rodrik et al. emphasize the centrality of institutions in understanding differences in income across countries. Does this imply that geography plays no role?

Answer 55

The Rodrik analysis reveals that while geography does not appear to be directly correlated with income levels, it is strongly correlated with institutional quality which in turn is strongly correlated with income levels. Thus geography does play an important role, but an indirect one.

Question 56

Institutions & international finance: In their review of policy approaches to deal with the problem of Odious debt, Doemeland et al (2009) warn that encouraging/facilitating debt repudiation could prompt new costs. Provide an example of such costs.

Answer 56

As lenders factor in the risk that at least some of their loans will be repudiated, they may raise the costs for all borrowers. In the case of the ex-ante odious regime policy, governments designated as odious regimes may choose to renege on their earlier, legitimate, debts, thereby further inducing lenders to raise interest rates for all borrowers in order to cover default risk.

Question 57

Institutions & international finance: Describe one of the key challenges with implementing an ex-ante Odious regime policy, such as was outlined by Jayachandran and Kremer (2006).

Answer 57

The ex-ante Odious regime policy proposal is predicated on the establishment or designation of a body that is empowered to designate existing regimes as odious or not. It is not clear how this body would be established and what process would be followed to identify odious regimes. The possible presence of odious lenders might make it even more difficult to reach consensus around the identification of odious regimes.

Question 58

Migration & global inequality: A sudden and significant inflow of migrants to Miami in 1980 resulted in a massive expansion of the unskilled labor force. Yet wage rates of the unskilled, relative to those of the skilled, did not fall. Why?

Answer 58

The inflow of migrants from Cuba to Miami had the effect of sharply reducing the flow of migrants from elsewhere in the US to Miami. As a result the downward pressure on wage rates induced by the Cuban migrants was offset by the labor market tightening effect of a reduction in migrants from other parts of the U.S.

Question 59

Migration & global inequality: In Israel, in the 1990s, a massive inflow of migrants put significant pressure on wages and employment rates. Describe a mitigating factor that helped to (partially) prop up wages and employment in the face of these pressures.

Answer 59

Alongside the in-migration there was significant accumulation of capital (largely financed from abroad) and this had the effect of boosting labor demand alongside the expansion of labor supply – thereby reducing the downward pressure on wages.

Question 60

Migration & global inequality: The paper by Branko Milanovic (2012) introduces three concepts of global inequality. Describe how each of these concepts is calculated and interpreted.

Answer 60

Concept 1 refers to measuring inequality across countries on the basis of average per capita income per country – with each country having equal weight in the calculation. Concept 2 takes concept 1 but then weights each country by its population so as to capture the fact that countries vary massively in terms of their contribution to the global population. Concept 3 treats each person in each country as an individual and looks at the individual’s respective income level. There is no attribution to the population of a given country that country’s respective average per capita income.

Question 61

Migration & global inequality: In what way does the decomposition of global inequality by Milanovic (2012) help us understand why international migration pressures are so high?

Answer 61

Decomposing global inequality into a within-country and between-country component reveals that by far the largest contribution to global inequality comes from average income differences between countries. Thus a person born in a poor country is unlikely to be able to climb very far up the global income ladder if he stays within his own country. The only way to make further progress is to move to a richer country (migrate).

Question 62

Trade liberalization: In their article on Trade Liberalization and Poverty Winters, McCulloch and McKay discuss various channels that link trade liberalization to household and individual poverty.

• Winters et al. argue that econometric techniques such as regressing a poverty indicator on an indicator of trade liberalization are ill-suited for assessing the impact of trade liberalization on poverty. What is their main argument?
• In their article the authors discuss various links from trade liberalization to output volatility and terms of trade volatility. (Briefly) discuss at least two of these links.
  
  • They also discuss the unequal impact that trade liberalization could have on individual household members. Discuss at least two ways in which household members could be differentially affected by trade liberalization.

Answer 62

• The relationship between poverty and TL will be very complex, and different for different countries. Also both will be subject to many external influences which will be impossible to cover all (or even part of it) in a regression.
• Macroeconomic volatility is one of the most important sources of risk for all households. Presumption is that open economies are less stable. More open capital markets should be associated with smoother consumption but more volatile investment, whereas more opengoods markets should be associated with greater output volatility. This is because goods market integration allows economies to specialize and thus reduces risk in spreading in production. However, don’t find significant correlations between openness and volatility, mainly because many shocks appear to be common across countries. Presumption that volatility causes uncertainty which in turn reduces investment and therefore growth. Empirical tests of this hypothesis give mixed results.
• Different policies may have different impact on intra-household allocation, e.g., new employment opportunities for women can increase burden for women and potentially affect investment in children’s human capital
  
  • Different impact on men’s or women’s activities can shift intra-household ‘balance of power’
  • Focusing on household total expenditure can therefore be misleading simplification

Question 63

Globalization: Over the last decades the wage gap between higher- and lower-skilled workers has widened in many countries. The same period has seen increased globalization (in the sense of freer flows of trade, production factors and information). This has raised the question whether globalization is a cause of increased wage inequality.

• Discuss two ways along which globalization would lead to increased wage inequality in advanced economies. (4 pts)
• Can these explanations also account for trends in wage inequality in emerging economies? Explain. (3 pts)
• Briefly discuss two other factors, not directly related to globalization, that have been used to explain increasing wage inequality. (3 pts)

Answer 63

• Samuelson-Stolper; migration
• One would expect the opposite trend in EEs, but in fact there we see the same trends as in AEs
• Technical progress biased in favour of high-skill labour; labour market policies
  
  • Labor market policies: growing industry concentration gives employers more power. Also the most important factor behind the collapse in workers’ bargaining power has been the erosion in the share of workers in a union.
  • Technical change: technical change favors more skilled (educated) workers (increases their productivity though tools such as computer), replaces tasks previously performed by the unskilled, and increases the demand for skills.

Question 64

Standards: Standards can be used as a non-tariff barrier to trade. However, they have also been found to facilitate trade. Explain.

Answer 64

• Pro: standards can help producers in product specification; they can facilitate intra-sector trade in sectors with world-wide supply chain.
  
  • International Standards mean that consumers can have confidence that their products are safe, reliable and of good quality.
• Con: they can also create barriers to entry because compliance is costly; standardization can help (e.g. containers) but also frustrate innovation

Question 65

Standards: Mention the pros (at least one) and cons (at least one) of international harmonization of standards.

Answer 65

Pro: political economy; monitoring compliance. Con: in a first-best world standards would be based on local fundamentals such as technology, tastes, resources; harmonized standards are likely to be sub-optimal from a welfare economic point of view

Question 66

Standards: Consider the problem of deciding on international harmonization of standards in the production of a particular tradable good. Explain why countries that are net exporters of the good would favour [higher / lower] standards (you must choose between the two) than countries that are net importers of the good.

Answer 66

Exporters would typically favour higher (harmonized) standards than importers, because high standers would lead to higher prices and therefore an improvement of the terms of trade for exporters

Question 67

Trade shocks, resources & civil war: Draw on the discussion in Rodrik et al. (2004) to comment briefly on the robustness of the findings in Collier and Hoeffler (2004).

Answer 67

Exam April 2020, figure out answer

Question 68

Migration & global inequality:

• In the Milanovic paper inequality has been “decomposed” in turn, for the year 1870 and the year 2000. Explain briefly how this decomposition permits an assessment of the relative salience of class versus location in understanding global inequality.
• Briefly explain how the decomposition referred to above draws on both concept 2 and concept 3 inequality measures as described by Milanovic.

Answer 68

Exam April 2020, figure out answer

Question 69

Trade shocks, resources & civil war: While the van der Ploeg and Poelhekke (2009) study does not study the precise mechanisms through which volatility is thought to affect growth, they refer to a number of possible economic arguments. Provide an example of how volatility might be expected to lower growth as well as one suggesting how volatility could increase growth.

Answer 69

• Lower growth:
  
  • Volatility could result in liquidity constraints for firms, driving reduced innovation, especially if financial institutions are poorly developed; with complete financial markets long-term investment is counter-cyclical, mitigating volatility.
  • Reduces risk-adjusted returns, which lowers investment as well as growth.
  • Political argument: bonanzas induce false sense of security
• Increase: Higher volatility leads to higher precautionary saving, resulting in higher investment and thus faster growth

Question 70

Institutions & international finance: In their review of policy approaches to deal with the problem of Odious debt, Domeland et al (2009) warn that encouraging/facilitating debt repudiation could penalize legitimate borrowers. Briefly explain why.

Answer 70

Exam April 2020, figure out answer

Question 71

Migration & global inequality: Williamson’s 2004 review of world mass migration during the 19^th and 20^th centuries suggests that across the two global centuries of migration, there was a fairly similar impact of migration on host-country inequality. What was this impact, and what was the likely mechanism driving it?

Answer 71

• the effects of U.S. immigration between 1979 and 1995
• were to reduce the earnings of skilled natives by 2.5 percent and the unskilled native born by 4.6 percent. Immigration therefore contributed to a rise in U.S. earnings inequality, the earnings ratio of the skilled to the unskilled having increased by 2.1 percent. If instead perfect world capital mobility is assumed (capital flows into the U.S. economy in response to immigration, keeping the rate of return constant), then earnings for skilled natives now actually increase (although only slightly) while those of unskilled natives fall by 4.6 percent as before. Therefore, the earnings ratio of the skilled to the unskilled increases by more (5 percent) when there is perfect world capital mobility and hence elastic capital supplies.
• There is a moral here that is worth stressing. Immigrant absorption is much easier in times when world capital markets are globally integrated. Under such conditions, world capital is allowed to chase after world migrations, augmenting the capacity of the host country to absorb the immigrants. Complaints about crowding-out and evidence of rising inequality are muted under such conditions, conditions satisfied before 1913 and after 1970. They were not satisfied between 1913 and 1970, when world capital markets were in a shambles.
• This analysis of the two centuries ignores some important differences in the character of the immigration and the structure of the economy—differences that should have mattered to the economywide impact. First, the late 20th century skill gap between immigrants and natives was five times larger than in the late 19thcentury; hence, the immigrants’ influence on reducing the host country skill mix— diluting its “quality”—should have been much greater in more recent times. Added to that, the unskilled are now a much smaller share of the U.S. labor force, and so a given immigrant inflow should make a proportionately larger contribution to the unskilled labor supply. Hence, the effects of immigration on the unskilled wage should be even greater today than they were a century ago. However, these forces have a potential offset, the absorptive capacity of the U.S. economy. Consider that agricultural employment, where labor was unskilled, accounted for muhc in 1870 then now. Land was a much more important factor of production a century ago—and land is a quasi-fixed factor. Given the importance of land, there were much stronger economywide diminishing returns to a rising unskilled labor force in the 19th century, effects that were only partly ameliorated by international capital mobility. For this reason, the same immigrant inflow had larger effects on unskilled earnings in the nineteenth century than it does today. Apparently trends in these two offsetting forces (a rising skill gap between immigrant and native born versus an improved capacity to absorb the immigrant) have been pretty much a wash, since the net effect of the two is similar then and now.

Question 72

Migration & global inequality: How do the examples Miami and Israel provide evidence of an exacerbating or attenuating effect of migration on inequality?

Answer 72

The inflow of migrants from Cuba to Miami had the effect of sharply reducing the flow of migrants from elsewhere in the US to Miami. As a result the downward pressure on wage rates induced by the Cuban migrants was offset by the labor market tightening effect of a reduction in migrants from other parts of the U.S.

Israel: Alongside the in-migration there was significant accumulation of capital (largely financed from abroad) and this had the effect of boosting labor demand alongside the expansion of labor supply – thereby reducing the downward pressure on wages.

Question 73

Trade liberalization: The following graph from the course slides roughly summarizes the channels from trade liberalization to poverty discussed in Winters, McCulloch and McKay.

• Without any doubt the covid-19 pandemic will have a profound impact on household welfare and poverty, but in this question we want you to speculate on how the corona crisis is likely to change the picture above. (We will grade your answers according to how much sense your arguments make from an economic point of view.)
• How (if at all) will the corona crisis affect trade between advanced and developing economies? Will this be different for free or restricted trade regimes? (3 points)
• In the picture choose the three channels that you think are going to be mostly affected by the corona crisis. In this sub-question explain how, according to the Winters et al. review, trade liberalization affects poverty along these three channels. (3 points)
• Explain why you think the corona crisis will be affecting these chosen channels, and how. (4 points)

Answer 73

Exam April 2020, figure out answer

Question 74

Globalization: The article by Helpman discussed in week 2 summarizes recent theories that attempt to link globalization to increasing inequality.

• Are these theories successful in explaining recent trends in inequality? Explain your answer.
• Many economists argue, based on the Samuelson-Stolper theorem, that globalization is likely to decrease income inequality in poor countries. Carefully explain their argument. Do you think the Samuelson-Stolper theorem is applicable in this context? Explain your answer.
• One common element in the theories discussed by Helpman is positive assortative matching (PAM) of workers and managers or firms. Explain intuitively how PAM is related to wage inequality.
• Consider matching between managers with effectiveness y, and workers with skill x. Total value added produced by m managers with effectiveness y, and n workers with skill x is (see function attached)
• Show that this production function satisfies log supermodularity.
• Consider two managers with effectiveness 1 and 2; and two workers with effectiveness 1 and 2. Assume that real wages are equal to marginal productivity. Calculate wages when the worker-manager match satisfies PAM.
• Let workers skills double to 2 and 4. Calculate again wages under PAM. What can you conclude about inequality?

Answer 74

• Clear
• Two sides:
  
  • On the one hand, trade liberalization makes economies more competitive and thus is likely to reduce disequalizing rents to insiders. The end of import substitution programs and associated rationing of access to foreign exchange has probably been the greatest single factor in reducing the corrosive effects of corruption and rent-seeking in Latin America. Trade liberalization can also generate new labor-intensive jobs in agriculture and manufacturing – raising the incomes for example of the rural poor. And trade liberalization implies cheaper imports, reducing the real costs of consumption for the urban poor – who after all unlike the rich use most of their income for consumption.
  • On the other hand, trade liberalization leads to growing wage gaps between the educated and uneducated, also in developing countries. Apparently the combination of technology change with the globalization of markets is raising the demand for and the wage premium to skilled labor faster than the educational system is supplying skilled and trainable workers. And the distribution of education, though improving slowly, is still highly unequal.
• PAM and wage ineqaulity: Workers with higher ability are matched with more-sophisticated firms. In this event more-able workers are paid higher wages, and the rate at which wages rise with ability depends on how strong the complementarity between worker ability and firm sophistication is in the productivity function. The rate of wage increase determines in turn wage inequality in this ability range.

Question 75

Standards: Bhagwati and Srinivasan argue that when trade barriers (e.g. import tariffs) are used to impose standards on trade partners this is often motivated by local interests and amounts to ill-disguised trade protection. On the other hand, empirical research on standards show that standards can also impact trade positively. Does this invalidate the points made by Bhagwati and Srinivasan?

Answer 75

Exam April 2020, figure out answer

Question 76

Standards: Business interests often call for a ‘level playing field’ when discussing competition with foreign firms. Do you think this is a useful concept in studying international trade? Explain.

Answer 76

Argument: Unfair trade: if you have to pay less attention to environmental standards (and therefore e.g. exports become more expensive), then field is not level playing

Political salience of these objections: argument for environmental diversity is perfectly legitimate since environment is differently valued between countries in the sense that the utility function defined on income and pollution is not identical and homothetic, but also because of differences in endowments in technologies; thus, argument that others with different CCII standards are illegitimately and unfairly reducing their costs does not hold

Question 77

Standards: Race to the bottom

Answer 77

Mixed evidence. Some evidence that lowering labour standards in one country correlated with lowering in another. Greater evidence for weakening of enforcement, rather than of the standards themselves – more so in DE than AE.

Question 78

Standards: Swann on relationship between TL and international standards

Answer 78

Finds positive relationship between international standards and exports/imports, especially for AE. International standards supportive of trade because of lowered transaction costs. For DE standards can form barriers to trade especially sanitary and technological barriers. For national standards, mixed positive and negative effects on trade. Positive correlation between standards and trade does not necessarily prove that standards are not harmful for trade. But the necessity for standards is so high that countries have to adopt international standards if they want to export more (reverse causality).

Standards two-edged sword:

• Beneficial to trade – help in product specification, facilitate intra-industry trade
• Harmful to trade – barriers to entry due to cost of compliance, standardization can hurt (or help) innovation

Question 79

Institutions & international finance: Ways to enforce sovereign debt

Answer 79

• Political – gunboat diplomacy, military action, trade sanctions, diplomatic sanctions.
• Legal – asset seizures, legal costs, legal difficulty in obtaining new loans. (although often legal decisions are difficult to enforce and creditors would rather settle for restructuring)
  
  • In a few cases where creditors have obtained judgments in their favor, they have found it difficult to collect on them
  • However, even just the threat of litigation can limit countries’ access to financing. For example, countries in default proceedings may have difficulties in obtaining letters of credit for trade purposes, because creditors fear repayments on new credit lines may be seized
• Market – Higher interest rates, reputational costs (legal and market mechanisms related) – however effects of default only last for a short time.
  
  • Defaulting countries face higher financing costs, as well as reduced access to loans. However, effects appear to be rather short-lived following resolution of the default.
  • Default is often associated with a decline in trade. Evidence shows that trade declines follow default. But it is difficult to demonstrate that they are caused by default as opposed to by the reason for default.
  • Default is often associated with lower GDP. Note however, that countries typically default in bad times, when GDP is trending downward.
  • Overall likely that market enforcement costs outweigh legal costs of default. Especially with debts to commercial creditors. With debts to official creditors, legal costs (statutory suspensions of new loans) likely dominate.

Question 80

Institutions & international finance: bad debt - bad reputation is self-reinforcing mechanism

Answer 80

May lead to:

• Higher financing costs
• Difficulty in obtaining loans
• Bad reputation may trigger capital flight

Question 81

Migration & global inequality: effect of migration on wages

Answer 81

According to theory, immigration increases labour supply, therefore lowering wages. If labour markets don’t clear, immigrants displace natives or increase ranks of unemployed. clearly workers lose, employers win.

Reality is more complicated:

• Immigrants may stimulate labour demand as goods/capital markets adjust.
• Unskilled immigrants may displace native unskilled, but native skilled may gain.
• Immigrants may be dependent on unemployment benefits – fiscal burden for natives.

Empirics:

• Modest negative impact on unskilled wages
• Increases inequality by raising skilled wages and lowering unskilled wages

Question 82

Migratio & global inequality: how to address global inequality?

Answer 82

3 ways to address global inequality:

• Higher growth in poor countries.
• Global redistributive schemes.
• Migration.

Question 83

Trade liebralization: supermodularity

Answer 83

• What types of matches maximize aggregate value? Becker showed that if the value of a match exhibits complementarity, then positive assortative matching maximizes the aggregate value of marriages; that is, the man with the largest value of the masculine characteristic is matched with the woman with the largest feminine characteristic etc. Complementarity of the values of matches means that the increase in the value of a match when the masculine characteristic is replaced with a larger one is larger the larger the feminine characteristic in the match. In other words, the marginal gain from a masculine characteristic is increasing in the attractiveness of the woman in the match. This property is also known as supermodularity.
• log supermodularity: The same logic can be applied to matching workers with managers or firms. An important difference between these types of matches and those in the above-described marriage market is that while one man is typically matched with one woman in a marriage, many workers are matched with a single manager or a single firm. These models use a stronger notion of complementarity in order to obtain clear portrayals of inequality; they assume that the natural logarithm of the value of a match exhibits complementarity. This property is also known as log supermodularity. This implies that a marginal increase in the characteristic of one party raises the marginal value of the other party’s characteristic proportionately more than the value of the match.

Question 84

Trade liberalization: Channels through which TL affects household income

Answer 84

• Growth and stability
  
  • Growth? Poverty reduction?
  • Productivity?
  • Macro stability?
    
    • Openness makes economy vulnerable to global shocks
    • On the other hand local shocks could well be stabilized by global integration
    • Opening-up might create opportunities (e.g. cash crops) only for those who can afford taking risks (typically not the poor). E.g., poor can suffer from higher food prices without being able to benefit from higher prices for cash crop goods
    • There is always a lot of moving in and out of poverty: effect TL difficult to isolate
    • Evidence on macro stability of TL is mixed
• Households
  
  • Prices transmitted? Prices: Markets must exist to transmit price changes
    
    • Zimbabwe: abolishing state monopoly (1990s) for buying cotton from farmers led to more competition, better prices and better input availability
    • Zambia: deregulation of maize market left remote farmers marginalized because they could no longer sell their maize
  • Markets created / destroyed?
  • Do households respond?
  • Spillovers?
  • Vulnerability?
• Wages and employment
  
  • More employment, higher wages?
  • Transitional unemployment?
  • Stolper-Samuelson (beware: unskilled labour not always the abundant factor (e.g. Latin America: natural resources and land)
• Government revenue
  • Less government revenue?
  • Less revenue bad for the poor
  • Taxes and spending:
    • Tariffs source of government revenue
    • Reduced revenue might lead to reduced pro- poor spending of government
    • Conversely, WTO rules do not allow new tariffs (which are often pro-rich anyway)
    • WTO bans on subsidies are not real constraint to government policies
    • Increased openness makes taxation of capital more difficult (Rodrik)
• Adjustment costs
  
  • Long-run benefits do not solve immediate poverty concerns
  • TL can create immediate hardship
  • Most important problem: what happens to market for unskilled labour? Some evidence points to fast adjustment. Labourers in heavily protected sectors can be hit hard by TL. Focus complementary policy on initially poor or near-poor, but political economy considerations (i.e. popular support) could call for wider focus

Question 85

Trade shocks, resources & civil war: indicators used in Collier’s grievance and opportunity models

Answer 85

• Opportunity model results (logit regression) - significant variables
  
  • Primary commodity exports (peaking at around 33% of GDP)
  • Secondary schooling, growth in preceding episode (negative)
  • Months of peace preceding conflict (proxying conflict-specific capital)
  • Miliary advantage (marginally significant)
  • Population
  • Per capita income (instead of schooling)
  • Diaspora variable – when interacted with months of preceding peace. Interpretation here is that diaspora helps to attenuate the loss of conflict specific capital via financing
• Quantitative indicators of grievance
  
  • Ethnic/religious hatred, proxied by polarization index of ethnic composition
  • Political repression, proxied by Polity III data set on political rights and autocracy & Gastil Index: measure of political openness
  • Political exclusion: exploitation of minority becomes more likely the larger the minority, since there is more to extract. Thus proxied by size of majority: majority = 45%-90% of population
  • Economic inequality: income: proxied by Gini coefficient, and ratio of top to bottom quintiles. Asset: Gini of land ownership

Question 86

Institutions & international finance: how does reputation explain why default leads to reduced access to financing?

Answer 86

• Reputation: explains why default leads to reduced access to finance in two ways: Adverse selection models: default provides signal that a government is a “bad payer” type, implying higher financing costs. Moral hazard models: creditors exclude defaulting countries from borrowing in the future in order to enforce payment.
• Note higher financing costs (higher interest rates) and/or reduced financing availability will have economy-wide impacts. “Bad payer” type signal could also signal poor protection of property rights, and trigger capital flight

Question 87

Institutions & international finance: advantages / disadvantages ex-ante odious regime

Answer 87

• Because there is no delay in establishing the illegitimacy of odious loans, legal costs are likely to decline. However working out arrears on legitimate debt would remain a time-consuming exercise, with associated costs.
• Reputational costs related to repudiating debt contracted by odious regime are likely to fall, partly because borrowing costs pre-default are likely to be higher
• Arrears on legitimate debt would result in restriction in the availability of financing for non-odious regimes, and will raise the cost of borrowing.
• While lending to odious regimes likely to fall, incentive of odious regimes to default on legitimate debt likely rises. Overall impact on legal costs is ambiguous.
• Ex-ante policy clearly identifies which loans are enforceable. In other respects this policy suffers from similar problems as ex-post variant.
• Also, non-trivial difficulties in establishing a process whereby odious regimes are identified.

Question 88

Institutions & international finance: advantages / disadvantages ex-post odious regime

Answer 88

• During time required to establish odious nature, access to financing during litigation will not improve.
• Success should allow for a workout at favorable terms. Although note Argentina achieved 70% haircut without odious regime framework.
• Cost of borrowing for all countries likely to rise as creditors price in an expected probability of regime being declared odious
• Regimes declared odious will be more likely to default on earlier, legitimate, debt. Creditors adhering to framework will be punished with defaults on loans to earlier predecessor regimes, while creditors lending to odious regimes are likely to be repaid (as long as odious regime remains in power).
• Availability of resources from official creditors is likely to diminish (as creditors are unable to predict perfectly which regimes are deemed ex-post odious).
• Welfare of legitimate regimes is likely to fall, as borrowing costs rise. Welfare in odious regimes also likely to fall – successor countries will have to incur high legal costs

Question 89

Institutions & international finance: advantages / disadvantages ex-ante odious loans

Answer 89

• Who would lend to projects that did not meet predefined standards?
• Relative to situation with non-odious debt policy, incentives to default could still be higher, if costs of verifying the legitimacy of loans are prohibitively high.
• Also official creditors may shy away from projects in which the costs of meeting the proposed standards would be very high, even if these projects are in the interest of the population.

Question 90

Institutions & international finance: advantages / disadvantages ex-post odious loans

Answer 90

• Legal costs are likely to be higher than current default mechanisms, audits also costly. Lags are likely to increase and so access to new financing will continue to hold in the interim. Note in particular the difficulty and subjectivity of certain definitions of odious debt. How to differentiate between a project that was good ex-ante but failed, and one that was failed because it was bad ex-ante?
• Market costs: not clear how mechanism would affect probability of default. Likely market costs would be similar or higher to situation without framework. Odious regimes may have lower incentive to default on legitimate debt.