I’m happy to say that I will become an assistant professor at Chicago Booth in July.
In the course of researching my job market paper, I read a lot of old or obscure literature related to the Linder hypothesis. It yielded some real gems. Unfortunately, I also unearthed some big disappointments. You’ll see what I mean in a moment.
For the moment, here’s the abstract of McPherson, Redfearn and Tieslau – “International trade and developing countries: an empirical investigation of the Linder hypothesis” in Applied Economics (2001), an article with 44 citations in Google Scholar:
This paper presents empirical evidence in support of the Linder hypothesis for five of the six East African developing countries studied here: Ethiopia, Kenya, Rwanda, Sudan and Uganda. This finding implies that these countries trade more intensively with others who have similar per capita income levels, as predicted by Linder. The contributions of this research are three-fold. First, new information is provided on the Linder hypothesis by focusing on developing countries. Second, this is one of very few analyses to capture both time-series and cross-section elements of the trade relationship by employing a panel data set. Third, the empirical methodology used in the analysis corrects a major shortcoming in the existing literature by using a censored dependent variable in estimation.
Now, here’s the abstract of Bukhari, Ahmad, Alam, Bukhari, and Butt – “An Empirical Analysis of the Linder Theory of International Trade for South Asian Countries” in The Pakistan Development Review (2005), with zero citations in Google Scholar:
This paper presents empirical evidence in support of the Linder theory of international trade for three of the South Asian countries, Bangladesh, India, and Pakistan. This finding implies that these countries trade more intensively with countries of other regions, which may have similar per capita income levels, as predicted by Linder in his hypothesis. The contribution of this research is threefold: first, there is new information on the Linder hypothesis by focusing on South Asian countries; second, this is one of very few analyses to capture both time-series and cross-section elements of the trade relationship by employing a panel data set; third, the empirical methodology used in this analysis corrects a major shortcoming in the existing literature by using a censored dependent variable in estimation.
It continues like this, paragraph for paragraph. Finally, we arrive at Table 2 of each paper. Here’s McPherson, Redfearn and Tieslau:
And here’s Bukhari, Ahmad, Alam, Bukhari, and Butt:
That’s Bangladesh-Kenya, India-Ethiopia, and Pakistan-Uganda with identical rows. The same thing occurs in Table 3. It continues, all the way through the concluding paragraphs.
You’ll recall that Ralph Ossa emphasized sectoral heterogeneity in trade elasticities as one reason the ACR formula might understate the gains from trade. I haven’t read it yet, but this new NBER WP by Andrei Levchenko and Jing Zhang also emphasizes the importance of sectoral heterogeneity in thinking about this topic:
[T]he simpler formulas that do not use information on sectoral trade volumes understate the true gains from trade dramatically, often by more than two-thirds. The error in the formulas across countries is strongly negatively correlated to the strength of Ricardian comparative advantage: the one-sector formula-implied gains understate the true gains from trade by more in countries with greater dispersion in sectoral productivity. The model-based exercise thus reinforces the main result of the paper that accounting for sectoral heterogeneity in productivity is essential for a reliable assessment of the gains from trade.
It’s that time of year again. Who’s on the job market this year with a paper on international trade?
As resident blogger, I’m going to exercise a point of personal privilege to note that I am on the job market this year. Please tell your friends who are on hiring committees.
Jonathan Dingel (Columbia): “The Determinants of Quality Specialization”
With that important piece of information out of the way, here are this year’s trade candidates:
- Vanessa Alviarez (Michigan): “Multinational Production and Comparative Advantage”
- Andrea Ariu (Université catholique de Louvain): “Crisis-Proof Services: Why Trade in Services Did not Suffer During the 2008-2009 Crisis”
- Dany Bahar (HKS): “Heavier than Air? Knowledge Transmission within the Multinational Firm”
- Xue Bai (Penn State): “How You Export Matters: Export Mode, Learning, and Productivity in China”
- Silja Baller (Oxford): “Product Quality, Market Size and Welfare: Theory and Evidence from French Exporters”
- Felipe Benguria (UVA): “Production and Distribution in International Trade: Evidence from Matched Exporter-Importer Data”
- Johannes Boehm (LSE): “The Impact of Contract Enforcement Costs on Outsourcing and Aggregate Productivity”
- Doug Campbell (UC Davis): “Relative Prices, Hysteresis, and the Decline of American Manufacturing”
- Cheng Chen (Princeton): “Management Technology and the Hierarchical Firm in the Global Economy”
- Eliav Danziger (Princeton): “Skill Acquisition and the Dynamics of Trade Induced Inequality”
- David DeRemer (Université libre de Bruxelles): “Domestic Policy Coordination in Imperfectly Competitive Markets”
- Jonathan Dingel (Columbia): “The Determinants of Quality Specialization”
- Raluca Dragusanu (HBS): “Firm-to-Firm Matching Along the Global Supply Chain”
- Daisuke Fujii (Chicago): “International Trade Dynamics with Sunk Costs and Productivity Shocks”
- Cecile Gaubert (Princeton): “Firm Sorting and Agglomeration”
- Hang-Wei Hao (UC Davis): “The China Puzzle: Theory and Evidence on the Behavior of Chinese Exports during the 2008-2009 Global Financial Crisis”
- Leo Karasik (Toronto): “New Exporters during the Great Recession: Is the Large Fixed Cost Story Marginal?”
- Adriaan Ten Kate (Chicago): “Industry composition, trade barriers and their welfare implications: Evidence from Peru’s trade liberalization”
- Minho Kim (WUSTL): “Multi-Stage Production and International Trade”
- Ahmad Lashkaripour (Penn State): “Breaking Down Elasticities: Rebuilding Gravity and the Gains from Trade”
- Chi-Hung Liao (UC Davis): “Pricing-to-Market in Quality Dimension and Income Inequality”
- Philip A. Luck (UC Davis): “Intermediate Good Sourcing, Wages and Inequality: From Theory to Evidence”
- Michael Maio (Minnesota): “Foreign Competition and Firm Productivity: A Principal-Agent Approach”
- Ryan Monarch (Michigan): “It’s Not You, It’s Me: Breakups in U.S.-China Trade Relationships”
- Joan Monras (Columbia): “Immigration and Wage Dynamics: Evidence from the Mexican Peso Crisis”
- Gabriel Smagghue (Sciences Po): “A new Method for Quality Estimation using Trade Data: An Application to French firms”
- Sebastian Sotelo (Chicago): “Trade Frictions and Agricultural Productivity: Theory and Evidence from Peru”
- Grigorios Spanos (Toronto): “Sorting in French Production Hierarchies”
- Walter Steingress (Montreal): “Entry barriers to international trade: product versus firm fixed costs”
- Claudia Steinwender (LSE): “Information Frictions and the Law of One Price: When the States and the Kingdom became United”
- Sebastian Stumpner (Berkeley): “Trade and the Geographic Spread of the Great Recession”
- Phyllis Kit Yee Sun (Princeton): “A Theory of Worker-Level Comparative Advantage and Task Specialization within Jobs”
- Pierre-Louis Vezina (Oxford): “Migrant Networks and Trade: The Vietnamese Boat People as a Natural Experiment”
- Andrea Waddle (Minnesota): “Trade, Technology and the Skill Premium: The Case of Mexico”
Paul Krugman’s 1980 AER paper formally introduced the home-market effect. In introducing his result, he mentions (p.955):
Notice that this argument is wholly dependent on increasing returns; in a world of diminishing returns strong domestic demand for a good will tend to make it an import rather than an export. But the point does not come through clearly in models where increasing returns take the form of external economies (see W. M. Corden). One of the main contributions of the approach developed in this paper is that by using this approach the home market can be given a simple formal justification.
I doubt that very many people have looked at the Corden reference, as it appeared in a 1970 conference volume titled Studies in international economics. Monash Conference papers. Here’s an excerpt from the surprisingly prescient three-page note:
A note on economies of scale, the size of the domestic market and the pattern of trade
Professor Grubel suggests that a country will tend to produce and export those products or ‘styles’ of products for which it has a relatively large domestic market. He explains this in terms of economies of scale. This is essentially the ‘Linder hypothesis’ which has obtained some empirical support, as well as being intuitively plausible. But it does raise an interesting theoretical question which has not, to my knowledge, been explored. In a simple static two-product two-country model with no transport costs, with economies of scale and with the demand patterns differing between the two countries it does not follow that a country will export that product to which its own demand pattern is biased. In that sort of model, as is well-known, one can say only that at least one of the two countries, and possibly both, will specialise, but one cannot say which country will specialise in which good. From the point of view of maximising potential world income there will be an optimum pattern of specialisation, but this will not depend in any simple predictable way on differences between the demand patterns of the two countries. Thus we cannot obtain the Linder hypothesis from this simple model. The question then is: What else must we put into the model? Is it transport costs, or is it rather something ‘dynamic’ ? In order to focus on the main point I shall now assume that the two countries are of equal size, that their factor endowments and production functions are identical, and that any differences between the factor-intensities of the two products are not large. Hence the two countries have identical convex production transformation curves. They differ only in their demand patterns. Country A’s demand pattern is biased towards product X and country B’s towards product Y. Needless to say, the discussion to follow is very tentative…
A third approach might be to introduce transport costs. Transporting goods from one country to another uses up resources, and from the point of view of maximising world income it will pay to minimise transport costs. Given that in the final equilibrium both countries will specialise, each country should then specialise on the good for which it has the relatively greater demand, since this will minimise transporting. This seems obvious. Provided we do not introduce other complications, trade along Linder lines will maximise potential world income. But it does not seem so easy to prove that trade will actually assume that pattern. Suppose that, for some reason, one starts with the trade flow in the opposite direction. One might explain this in terms of some dynamic considerations. Will there then be a natural tendency for the pattern of specialisation and hence the flow of trade to reverse itself? It does not seem obvious that this would be so. There is scope for further theoretical explorations here.
As Krugman himself has commented: “Now it is always tricky to reread old texts in the light of subsequent information; knowing what actually happened, you can probably find a prophecy of Nostradamus that fits the event, and knowing subsequent developments in economic theory, you can probably find most of it hinted at in Ibn Khaldun.” Still, I think Corden was onto something in 1970.
In August 1935, Gottfrieb Haberler wrote (Theory of International Trade, Preface to the English Edition):
[I]t seems to me that the theory of international trade, as outlined in the following pages, requires further development, in two main directions. The theory of imperfect competition and the theory of short-run oscillation (business cycle theory) must be applied to the problems of international trade. It will soon be possible to do this in a systematic way, since much progress has been made in both fields in recent years.
With regard to the first of these questions, there is the literature which centres around the two outstanding books, Monopolistic Competition by Professor E. Chamberlin and Imperfect Competition by Mrs. Joan Robinson. In the second field where further development is required, it is not so easy to refer to a body of accepted theory.
In a recent VoxEU column, Marc Melitz and Stephen Redding describe the logic of Melitz (Ecma, 2003) and Arkolakis, Costinot, and Rodriguez-Clare (AER, 2012). Those should be familiar to Trade Diversion readers (e.g. ACR 2010 wp, Ossa 2012 wp). They then explain their new paper:
In Melitz and Redding (2013b), we show that firm-level responses to trade that generate higher productivity do in fact represent a new source of gains from trade.
- We start with a model with heterogeneous firms, then compare it to a variant where we eliminate firm differences in productivity while keeping overall industry productivity constant.
We also keep all other model parameters (such as those governing trade costs and demand conditions) constant.
- This ‘straw man’ model has no reallocations across firms as a result of trade and hence features no productivity response to trade.
Yet it is constructed so as to deliver the same welfare prior to trade liberalisation. We then show that, for any given reduction in trade costs, the model with firm heterogeneity generates higher aggregate welfare gains from trade because it features an additional adjustment margin (the productivity response to trade via reallocations). We also show that these differences are quantitatively substantial, representing up to a few percentage points of GDP. We thus conclude that firm-level responses to trade and the associated productivity changes have important consequences for the aggregate welfare gains from trade.
How can these findings be reconciled with the results obtained by Arkolakis, Costinot, and Rodriguez-Clare (2012)? Their approach compares models that are calibrated to deliver the same domestic trade share and trade elasticity (the sensitivity of aggregate trade to changes in trade costs). In so doing, this approach implicitly makes different assumptions about demand and trade costs conditions across the models that are under comparison (Simonovska and Waugh 2012). By assuming different levels of product differentiation across the models, and assuming different levels of trade costs, it is possible to have the different models predict the same gains from trade – even though they feature different firm-level responses. In contrast, our approach keeps all these ‘structural’ demand and cost conditions constant, and changes only the degree of firm heterogeneity (Melitz and Redding 2013b). This leads to different predictions for the welfare gains from trade.
One potential criticism of our approach is that one can estimate the trade elasticity (the sensitivity of aggregate trade to changes in trade costs) using aggregate trade data only – without requiring any specific assumptions about the firm-level responses to trade. Whatever assumptions are made about those firm-level responses (and the demand and trade-cost conditions), they should then be constructed so as to match that estimated aggregate elasticity. However, recent empirical work has shown that those underlying assumptions radically affect the measurement of the aggregate trade elasticity, and that this trade elasticity varies widely across sectors, countries, and the nature of the change in trade costs (see for example Helpman et al. 2008, Ossa 2012, and Simonovska and Waugh 2012). There is thus no single empirical trade-elasticity parameter that can be held constant across those different models.
Given the lack of a touchstone set of elasticities, we favour our approach to measuring the gains from trade arising from different models; one that maintains the same assumptions about demand and trade costs conditions across those models.
You’ve no doubt noticed that recently I’ve only been posting once or twice per month. However, I am regularly sharing links and brief comments on Twitter, so you should follow @TradeDiversion. Recently on the Twitter feed (but not the blog):
- 13 May: Summer conferences: Schedules for Princeton IES and NBER ITI are up. http://www.princeton.edu/~ies/workshop.htm & http://users.nber.org/~confer/2013/SI2013/ITI/itiprg.html
- 12 May: World trade: Fresh blood http://econ.st/10uiFGB “The fate of the WTO’s Doha round is in the hands of two new trade officials” @TheEconomist
- 12 May: Kiminori Matsuyama’s symmetry-breaking model of endogenous comparative advantage is forthcoming in Econometrica: http://faculty.wcas.northwestern.edu/~kmatsu/
- 10 May: John Taylor relays rumors that “World Bank will water down or even abandon its ten-year old Doing Business” measures. http://economicsone.com/2013/05/09/10-years-doing-business-measuring-results-and-now-bill-gates/
I haven’t seen a book review like this in some time. Harry Johnson didn’t hold back while expressing his opinion of Linder (1961). This is the closing paragraph of his rather blunt five-page review:
In summary, this is at once an ambitious, provocative, and provoking book-ambitious in the breadth and depth of the problems in trade theory it propounds and seeks to solve, provocative in the hypotheses it propounds, and provoking on account both of the perverse misinterpretations of existing theory that the author produces to support his claims to novelty and of the careless botch he makes of the exposition of his own alternative theories. The result is a volume that ought to be read by specialists looking for seminal ideas and interesting research problems,but that cannot be recommended for use by students insufficiently trained to be alert to the substitution of emotive debating points for reasoned argument and of irrelevance for logical analysis. [Economica, 1964]