GGD Flashcards
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?
- 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.
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.
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.
Standards: Discuss the merits of harmonization of standards from the points of view of welfare theory and political economy.
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.
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?
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.
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?
- 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.]
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)?
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
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?
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
Trade shocks, resources & civil war: What is the concern that Brunnschweiler and Bulte (2008) raise with respect to the standard Sachs and Warner analysis?
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.
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?
“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).
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.
- 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.
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).
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.
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.
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.
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?
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.
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?
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.
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?
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).
Migration & global inequality: Williamson’s 2004 review of world mass migration during the 19th and 20th 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?
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.
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?
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.
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.
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
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?
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.
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)
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.
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.
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.
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?
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.
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?
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.
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?
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).
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.
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.
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 19th and late 20th centuries has led to increased pressure to migrate. Briefly elaborate on these two authors’ arguments.
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.
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?
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.
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.
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.
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 pw 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.
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.
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?
There is no import of the good, so the tariff will change nothing.
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?
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.
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?
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.
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.
- 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
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.
- 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
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.
(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
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.
(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
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)
Exam April 2020, figure out answer
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?
- 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.
