Research

Trade Protection, Stock-Market Returns, and Welfare

with Mary Amiti and Sang Hoon Kong. Read discussions in Forbes and The Wall Street Journal.

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Abstract: We show that the specific factors model can be used to derive a rigorous link between movements in stock prices and productivity, wages, employment, output, and welfare. We also prove that the commonly used measure of the effective rate of protection equals the dual measure of revenue TFP, providing a theoretical foundation for why many studies have found that trade liberalization significantly increases firm-level productivity. Our method enables us to trace a tariff announcement’s effect on TFP through its impact on macro variables (e.g., exchange rates) and through its effect on the relative prices of imports. We apply this framework to understanding the implications of the U.S.-China trade war. Our results show that the trade-war announcements caused large declines in U.S. stock prices, expected TFP, and expected inflation largely by moving macro variables, but also by causing declines in the returns of firms trading with China. We find that markets expect the trade war to lower U.S. welfare by 7.8 percentage points, which is much larger than the predictions of static models but in line with those of dynamic models.

The Effect of the U.S.-China Trade War on U.S. Investment

with Mary Amiti and Sang Hoon Kong, NBER Working Paper 27114)  (FRBNY Blog Post) Read discussions in Bloomberg, Forbes, The Wall Street Journal, and MarketWatch.
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Abstract: We develop a new method of quantifying the impact of policy announcements on investment rates that makes use of stock market data. By estimating the effect of U.S.- China tariff announcements on aggregate returns and the differential returns of firms exposed to China, we identify their effect on treated and untreated firms. We show theoretically and empirically that estimates of policy-induced stock-market declines imply lower returns to capital, which lowers investment rates. We estimate that the tariff actions through 2018 and 2019 will lower the investment growth rate of listed U.S. companies by 1.9 percentage points by the end of 2020.

 

Who’s Paying for the U.S. Tariffs? A Longer-Term Perspective

with Mary Amiti and Stephen J. Redding, CEPR Discussion Paper 6741)  
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Abstract: Using data from 2018, a number of studies have found that recent U.S tariffs have been passed on entirely to U.S. importers and consumers. These results are surprising given that trade theory has long stressed that tariffs applied by a large country should drive down foreign prices. Using another year of data including significant escalations in the trade war, we find that U.S. tariffs continue to be almost entirely borne by U.S. firms and consumers. We show that the response of import values to the tariffs increases in absolute magnitude over time, consistent with the idea that it takes time for firms to reorganize supply chains. We find heterogeneity in the responses of some sectors, such as steel, where tariffs have caused foreign exporters to drop their prices substantially, enabling them to export relatively more than in sectors where tariff passthrough was complete.

 

The Impact of E-Commerce on Relative Prices and Welfare

(with Yoon J. Jo and Misaki Matsumura)
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Abstract: This paper examines the impact of e-commerce on pricing behavior and welfare. Using Japanese data, we find that the entry of e-commerce firms significantly raised the rate of intercity price convergence for goods sold intensively online, but not for other goods. E-commerce also lowered relative inflation rates for goods sold intensively online. We overcome data challenges using long data series and historical catalog sales as an instrument for e-commerce sales intensity. We estimate that reductions in price dispersion raised welfare by 0.3 percent. E-commerce also lowered variety-adjusted prices on average by 0.9 percent, and more in cities with highly educated populations.

 

The Impact of the 2018 Trade War on U.S. Prices and Welfare

Journal of Economic Perspectives, Fall 2019. (with Mary Amiti and Stephen J. Redding. Replication Files Read discussions in Paul Krugman’s Column in the  New York Times,  New York Times, New York Times Editorial, Wall Street Journal I, Wall Street Journal II,  NPR Marketplace, NPR All Things Considered, BBC, Financial Times I, Financial Times II, Washington Post, Washington Post PowerPost, The Economist,  Spiegel Online, Bloomberg, Time Magazine, Chicago Tribune, Associated Press, Fortune, CNBC, PBS Newshour, VoxTalkVanity Fair, Yahoo Finance 1, Yahoo Finance 2, Barrons, Business Insider, Japan Times, China Daily, South China Morning Post, and Washington Examiner
Download Paper  or read my Chicago Stigler Center Blog for a nontechnical version.

Abstract: This paper explores the impacts of the Trump administration’s trade policy on prices and welfare. Over the course of 2018, the U.S. experienced substantial increases in the prices of intermediates and final goods, dramatic changes to its supply-chain network, reductions in availability of imported varieties, and complete passthrough of the tariffs into domestic prices of imported goods. Overall, using standard economic methods, we find that the full incidence of the tariff falls on domestic consumers, with a reduction in U.S. real income of $1.4 billion per month by the end of 2018. We also see similar patterns for foreign countries who have retaliated against the U.S., which indicates that the trade war also reduced real income for other countries.

 

Measuring Aggregate Price Indexes with Taste Shocks: Theory and Evidence for CES Preferences

(with Stephen J. Redding and formerly titled “A Unified Approach to Aggregate Price and Welfare Measurement”), Quarterly Journal of Economics, forthcoming.
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Abstract: We develop an approach to measuring the cost of living for CES preferences that treats demand shocks as taste shocks that are equivalent to price shocks. In the presence of relative taste shocks, the Sato-Vartia price index is upward biased because an increase in the relative consumer taste for a good lowers its taste-adjusted price and raises its expenditure share. By failing to allow for this association, the Sato-Vartia index underweights drops in taste-adjusted prices and overweights increases in taste-adjusted prices, leading to what we term a “consumer-valuation bias.” We show that this bias generalizes to other invertible demand systems.

 

Aggregation and the Gravity Equation

(joint with Stephen J. Redding), paper prepared for American Economic Review, Papers and Proceedings, NBER Working Paper, 25464, CEPR Discussion Paper, 6741-1547320785, January 2019.

Abstract: We use the nested constant elasticity of substitution (CES) demand system to show that a log-linear gravity equation holds exactly at each nest of utility. Using the independence of irrelevant alternatives (IIA) properties of CES, we derive an exact Jensen’s inequality correction term for aggregation across the nests of the utility function. We use this result to decompose the overall effect of distance on bilateral trade in the aggregate gravity equation into the contribution of different terms from sectoral gravity equations: (i) origin fixed effects; (ii) destination fixed effects; (iii) distance; (iv) our Jensen’s inequality or composition term; and (v) the error term.

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Accounting for Trade Patterns

(with Stephen Redding)

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Abstract: We develop a quantitative framework for exactly decomposing trade patterns into economically meaningful components. We derive price indexes that determine comparative advantage across countries and sectors and the aggregate cost of living. If firms and products are imperfect substitutes, we show that these price indexes depend on variety, average demand or quality, and the dispersion of demand or quality-adjusted prices, and are only weakly related to standard empirical measures of average prices, thereby providing insight for elasticity puzzles. Of the cross-section (time-series) variation in comparative advantage, 50 (90) percent is accounted for by variety and average demand or quality, with average prices contributing less than 10 percent.

The Crisis that Wasn’t: How Japan Has Avoided a Bond Market Panic

(with Mark T. Greenan)

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Abstract: This paper explores the history of Japanese fiscal policy over the past two decades with the aim of better understanding where previous forecasts have erred. As such, Japan provides an important case study of how a country facing intense fiscal pressures can avoid a hyperinflation or financial panic. We find that there were three key forces that likely improved Japan’s fiscal situation relative to more pessimistic predictions. First, the Japanese government has shown remarkable ability to hold down per capita expenditures on social pensions and healthcare. Second, the Japanese government has been able to raise taxes substantially. Third, the remarkable monetary policy pursued by the Bank of Japan has resulted in a dramatic decline in the amount of government bonds held by the private sector.

 

Supply- and Demand-Side Factors in Global Banking

(with Mary Amiti and Patrick McGuire)

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Abstract: What is the role for supply and demand forces in determining movements in international banking flows? Answering this question is crucial for understanding the international transmission of financial shocks and formulating policy. This paper addresses the question by using the method developed in Amiti and Weinstein (forthcoming) to exactly decompose the growth in international bank credit into common shocks, idiosyncratic supply shocks and idiosyncratic demand shocks for the period 2000-2016. A striking feature of the global banking flows data can be characterized by what we term the “Anna Karenina Principle”: all healthy credit relationships are alike, each unhealthy credit relationship is unhealthy in its own way. During non-crisis years, bank flows are well-explained by a common global factor and a local demand factor. But during times of crisis flows are affected by idiosyncratic supply shocks to a borrower country’s creditor banks. This has important implications for why standard models break down during crises.

How Much do Idiosyncratic Bank Shocks Affect Investment? Evidence from Matched Bank-Firm Data

(with Mary Amiti)
Journal of Political Economy, April 2018
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  • Stata ado file to run estimation with one command: AWShock

Abstract: We show that supply-side financial shocks have a large impact on firms investment. We do this by developing a new methodology to separate firm credit shocks from loan supply shocks using a vast sample of matched bank-firm lending data. We decompose loan movements in Japan for the period 1990 to 2010 into bank, firm, industry, and common shocks. The high degree of financial institution concentration means that individual banks are large relative to the size of the economy, which creates a role for granular shocks as in Gabaix (2011). As a result, idiosyncratic bank shocks—i.e., movements in bank loan supply net of borrower characteristics and general credit conditions—can have large impacts on aggregate loan supply and investment. We show that these idiosyncratic bank shocks explain 40 percent of aggregate loan and investment fluctuations.

Quantifying the Sources of Firm Heterogeneity

(with Colin Hottman and Stephen J. Redding)
Quarterly Journal of Economics, July 2016.
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Online Appendix; Program Codes and Data

Abstract: We develop and structurally estimate a model of heterogeneous multiproduct firms that can be used to decompose the firm-size distribution into the contributions of costs, “appeal” (quality or taste), markups, and product scope. Using Nielsen bar-code data on prices and sales, we find that variation in firm appeal and product scope explains at least four fifths of the variation in firm sales. We show that the imperfect substitutability of products within firms, and the fact that larger firms supply more products than smaller firms, implies that standard productivity measures are highly dependent on implicit demand system assumptions and probably dramatically understate the relative productivity of the largest firms. Although most firms are well approximated by the monopolistic competition benchmark of constant markups, we find that the largest firms that account for most of aggregate sales depart substantially from this benchmark, and exhibit both variable markups and substantial cannibalization effects.

Globalization, Markups and U.S. Welfare

(with Robert Feenstra)
Journal of Political Economy, September, 2017.
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Abstract: This paper is the first attempt to structurally estimate the impact of globalization on markups and welfare in a monopolistic competition model. To achieve this, we work with a class of preferences that allow for endogenous markups and firm entry and exit that are especially convenient for empirical work ?the translog preferences, with symmetry in substitution imposed across products. Between 1992 and 2005 we find the U.S. market experienced a series of changes that confirm the predictions of Melitz and Ottaviano (2008): import shares rose and U.S. firms exited, leading to a fall in markups, while product variety and welfare went up. We estimate the impacts of these effects on a national level, and find a cumulative drop of 5.4 percent in merchandise prices and of 1.0 percent in overall consumer prices between 1992 and 2005. Although the magnitude of the welfare gains in our translog setup is similar to that obtained by assuming CES preferences, the sources of these gains are quite different. Variety gains under translog are at least one-third smaller than in the CES case, but there is a substantial reduction in U.S. markups, resulting in a comparable welfare gain overall.

How Much do Official Price Indexes Tell us about Inflation?

(with Jessie Hanbury and Tsutomu Watanabe)
NBER Wroking Paper #19504, October 2013
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Abstract: Official price indexes, such as the CPI, are imperfect indicators of inflation calculated using ad hoc price formulae different from the theoretically well-founded inflation indexes favored by economists. This paper provides the first estimate of how accurately the CPI informs us about ¡§true¡¨ inflation. We use the largest price and quantity dataset ever employed in economics to build a Tornqvist inflation index for Japan between 1989 and 2010. Our comparison of this true inflation index with the CPI indicates that the CPI bias is not constant but depends on the level of inflation. We show the informativeness of the CPI rises with inflation. When measured inflation is low (less than 2.4% per year) the CPI is a poor predictor of true inflation even over 12-month periods. Outside this range, the CPI is a much better measure of inflation. We find that the U.S. PCE Deflator methodology is superior to the Japanese CPI methodology but still exhibits substantial measurement error and biases rendering it a problematic predictor of inflation in low inflation regimes as well.

Evaluating the Economic Response to Japan’s Earthquake

(with Molly Schnell)
RIETI Policy Discussion Paper Series, February 2012.
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Abstract: This paper compares the 1995 Kobe earthquake with the more recent one in Tohoku. The impact of the recent earthquake on industrial production was much larger and long-lasting than that of the 1995 earthquake. We find that very little of this can be explained by differences in government expenditures or private consumption. However, we find very substantial differences in energy production in the wake of the two earthquakes. The substantial and persistent drop in energy output is likely to have exacerbated supply disruptions and may continue to slow the pace of recovery. Moreover, we provide some evidence that Japan’s increasing reliance on fossil fuel sources of energy is likely to result in a large number of deaths and increases in morbidity due to increased air pollution. These results highlight the difficulties that Japan is likely to face in its move away from nuclear power.

Exports and Financial Shocks

(with Mary Amiti)
Quarterly Journal of Economics, November 2011.
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Program Files and Data Sources

Abstract: A striking feature of many financial crises is the collapse of exports relative to output. In the 2008 financial crisis, real world exports plunged 17 percent while GDP fell 5 percent. This paper examines whether the drying up of trade finance can help explain the large drops in exports relative to output. This paper is the first to establish a causal link between the health of banks providing trade finance and growth in a firm’s exports relative to its domestic sales. We overcome measurement and endogeneity issues by using a unique data set, covering the Japanese financial crises of the 1990s, which enables us to match exporters with the main bank that provides them with trade finance. Our point estimates are economically and statistically significant, suggesting that trade finance accounts for about one-third of the decline in Japanese exports in the financial crises of the 1990s.

Trade Finance and the Great Trade Collapse

(with JaeBin Ahn and Mary Amiti)
American Economic Review Papers and Proceedings, May 2011.
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Abstract: While there is no question that demand played a major part in the decline in world trade, there is increasing evidence that the liquidity contractions that rocked the financial world also played a part. Firm level evidence indicates that exporters whose financial institutions became unhealthy cut back on exports more than other firms, and imports declined more in sectors that had greater external financial dependence. This paper shows that some of these shocks may also have appeared in price movements. Export prices rose relative to domestic manufacturing prices during the crisis, and the prices of seaborne imports and exports—which are more sensitive to financial shocks—rose relative to goods sent by land or air.

Goods Prices and Availability in Cities

(with Jessie Handbury)
Review of Economic Studies, July 2014.
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Abstract: The agglomeration force behind the New Economic Geography literature initiated by Krugman is based on the notion that larger markets should have a lower variety adjusted price index. Despite his Nobel Prize, there have been no tests of this idea. This paper represents the first such test. Using a rich dataset covering 10-20 million purchases of grocery items, we find that after controlling for store and shopping effects: 1) Aggregate grocery prices are lower in larger cities; 2) Residents of larger cities have access to substantially more varieties than residents of smaller cities; and 3) These forces combine to substantially lower variety adjusted prices in large cities. In short, Krugman was right.

Product Creation and Destruction: Evidence and Price Implications

(with Christian Broda and Ephraim Leibtag)
American Economic Review, June 2010.
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Abstract: This paper describes the extent and cyclicality of product creation and destruction in a large sector of the U.S. economy and quantifies its implications for the measurement of consumer prices. We find four times more entry and exit in product markets than is typically found in labor markets because most product turnover happens within the boundaries of the firm. Net product creation is strongly pro-cyclical, but contrary to the behavior of labor flows, it is primarily driven by creation rather than destruction. High rates of innovation are also accompanied by substantial price volatility of products. These facts suggest that the CPI deviates from a true cost-of-living index in three important dimensions. The quality bias that arises as new goods replace outdated ones causes the CPI to overstate inflation by 0.8 percent per year; the cyclicality of the bias implies that business cycles are more volatile than indicated by official statistics; and finally, sampling error is sufficiently large that over the last 10 years policymakers could not statistically distinguish whether quarterly inflation was accelerating or decelerating 65 percent of the time.

The Role of Prices in Measuring the Poor’s Living Standards

(with Christian Broda and Ephraim Leibtag)
Journal of Economic Perspectives, Spring 2009.
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Abstract: Almost 50 years after President Lyndon Johnson’s famous 1964 State of the Union speech that introduced the “War on Poverty,?two facts stand out in the current debate about poverty. First, since David Caplovitz (1963) wrote his path-breaking book, The Poor Pay More,numerous researchers have confirmed that the poor indeed pay more than households of higher income for the goods and services they purchase. Second, official poverty rates as measured by the U.S. Census have remained essentially flat since the late 1960s, raising questions about the success of the policies implemented to reduce poverty. In this paper we revisit these two facts by paying close attention to the price data underlying these findings. By examining scanner data on thousands of household purchases we find that the poor pay less—not more—for the goods they purchase. In addition, by extending the advances on price measurement in the recent decade back to the 1970s, we find that current poverty rates are less than half of the official numbers. This finding underscores the importance of correctly measuring the evolution of prices to determine the appropriate poverty thresholds over time. Both findings are contrary to the conventional wisdom established in the last few decades.

Understanding International Price Differences Using Barcode Data

(with Christian Broda)
NBER Working Paper #14017, May 2008.
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Abstract: The empirical literature in international finance has produced three key results about international price deviations: borders give rise to flagrant violations of the law of one price, distance matters enormously for understanding these deviations, and most papers find that convergence rates back to purchasing power parity are inconsistent with the evidence of micro studies on nominal price stickiness. The data underlying these results are mostly comprised of price indexes and price surveys of goods that may not be identical internationally. In this paper, we revisit these three stylized facts using massive amounts of US and Canadian data that share a common barcode classification. We find that none of these three main stylized facts survive. We use our barcode level data to replicate prior work and explain what assumptions caused researchers to find different results from those we find in this paper. Overall, our work is supportive of simple pricing models where the degree of market segmentation across the border is similar to that within borders.

Exporting Deflation? Chinese Exports and Japanese Prices

(with Christian Broda)
NBER Working Paper #13942, April 2008.
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Abstract: Between 1992 and 2002, the Japanese Import Price Index registered a decline of almost 9 percent and Japan entered a period of deflation. We show that much of the correlation between import prices and domestic prices was due to formula biases. Had the IPI been computed using a pure Laspeyres index like the CPI, the IPI would have hardly moved at all. A Laspeyres version of the IPI would have risen 1 percentage point per year faster than the official index. Second we show that Chinese prices did not behave differently from the prices of other importers. Although Chinese prices are substantially lower than the prices of other exporters, they do not exhibit a differential trend. However, we estimate that the typical price per unit quality of a Chinese exporter fell by half between 1992 and 2005. Thus the explosive growth in Chinese exports is attributable to growth in the quality of Chinese exports and the increase in new products being exported by China.

Optimal Tariffs and Market Power: The Evidence

(with Christian Broda and Nuno Limao)
The American Economic Review, December 2008.
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Abstract: We find that prior to World Trade Organization membership, countries set import tariffs 9 percentage points higher on inelasticallysupplied imports relative to those supplied elastically. The magnitude of this effect is similar to the size of average tariffs in these countries, and market power explains more of the tariff variation than a commonly used political economy variable. Moreover, US trade restrictions not covered by the WTO are significantly higher on goods where the United States has more market power. We find strong evidence that these importers have market power and use it in setting noncooperative trade policy.

Defining Price Stability in Japan: A View from America

(with Christian Broda)
NBER Working Paper #13255, July 2007.
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Abstract: Japanese monetary and fiscal policy uses the consumer price index as a metric for price stability. Despite a major effort to improve the index, the Japanese methodology of calculating the CPI seems to have a large number of deficiencies. Little attention is paid in Japan to substitution biases and quality upgrading. This implies that important methodological differences have emerged between the U.S. and Japan since the U.S. started to correct for these biases in 1999. We estimate that using the new corrected U.S. methodology, Japan’s deflation averaged 1.2 percent per year since 1999. This is more than twice the deflation suggested by Japanese national statistics. Ignoring these methodological differences misleading suggests that American real per capita consumption growth has been growing at a rate that is almost 2 percentage points higher than that of Japan between 1999 and 2006. When a common methodology is used Japan’s growth has been much closer to that of the U.S. over this period. Moreover, we estimate that the bias of the Japanese CPI relative to a true cost-of-living index is around 2 percent per year. This overstatement in the Japanese CPI in combination with Japan’s low inflation rate is likely to cost the government over 69 trillion yen — or 14 percent of GDP — over the next 10 years in increased social security expenses and debt service. For monetary policy, the overstatement of inflation suggests that if the BOJ adopts a formal inflation target without changing the current CPI methodology a lower band of less than 2 percent would not achieve its goal of price stability.

A Search for Multiple Equilibria in Urban Industrial Structure

(with Donald R. Davis)
Journal of Regional Science, 2008.
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Abstract: Theories featuring multiple equilibria are now widespread across many fields of economics. Yet little empirical work has asked if such multiple equilibria are salient features of real economies. We examine this in the context of the Allied bombing of Japanese cities and industries in WWII. We develop a new empirical test for multiple equilibria and apply it to data for 114 Japanese cities in eight manufacturing industries. The data provide no support for the existence of multiple equilibria. In the aftermath even of immense shocks, a city typically recovers not only its population and its share of aggregate manufacturing, but even the specific industries it had before.

From Groundnuts to Globalization: A Structural Estimate of Trade and Growth

(with Christian Broda and Joshua Greenfield)
NBER Working Paper #12512, September 2006.
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Abstract: Starting with Romer [1987] and Rivera-Batiz-Romer [1991] economists have been able to model how trade enhances growth through the creation and import of new varieties. In this framework, international trade increases economic output through two channels. First, trade raises productivity levels because producers gain access to new imported varieties. Second, increases in the number of varieties drives down the cost of innovation and results in ever more variety creation. Using highly disaggregate trade data, e.g. Gabon’s imports of Gambian groundnuts, we structurally estimate the impact that new imports have had in approximately 4000 markets per country. We then move from groundnuts to globalization by building an exact TFP index that aggregates these micro gains to obtain an estimate of trade on productivity growth for each country. We find that in the typical country in the world, new imported varieties account for 15 percent of its productivity growth. These effects are larger in developing countries where the median impact of new imported varieties equals a quarter of national productivity growth.

Globalization and the Gains from Variety

(with Christian Broda)
Quarterly Journal of Economics, May 2006.
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Abstract: Since the seminal work of Krugman (1979), product variety has played a central role in models of trade and growth. In spite of the general use of love-of-variety models, there has been no systematic study of how the import of new varieties has contributed to national welfare gains in the United States. In this paper we show that the unmeasured growth in product variety from US imports has been an important source of gains from trade over the last three decades (1972-2001). Using extremely disaggregated data, we show that the number of imported product varieties has increased by a factor of four. We also estimate the elasticities of substitution for each available category at the same level of aggregation, and describe their behavior across time and SITC-5 industries. Using these estimates we develop an exact price index and find that the upward bias in the conventional import price index is approximately 1.2 percent per year. The magnitude of this bias suggests that the welfare gains from variety growth in imports alone are 2.8 percent of GDP.

Happy News from the Dismal Science: Reassessing Japanese Fiscal Policy and Sustainability

(with Christian Broda)
NBER Working Paper #10988, December 2004.
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Abstract: We analyze fiscal policy and fiscal sustainability in Japan using a variant of the methodology developed in Blanchard (1990). We find that Japan can achieve fiscal sustainability over a 100-year horizon with relatively small changes in the tax-to-GDP ratio. Our analysis differs from more pessimistic analyses in several dimensions. First, since Japanese net debt is only half that of gross debt, we demonstrate that the current debt burden is much lower than is typically reported. This means that monetization of the debt will have little impact on Japan’s fiscal sustainability because Japan’s problem is the level of future liabilities not current ones. Second, we argue that one obtains very different projections of social security burdens based on the standard assumption that Japan’s population is on a trend towards extinction rather than transitioning to a new lower level. Third, we demonstrate that some modest cost containment of the growth rate of real per capita benefits, such as cutting expenditures for shrinking demographic categories, can dramatically lower the necessary tax burden. In sum, no scenario involves Japanese taxes rising above those in Europe today and many result in tax-to-GDP ratios comparable to those in the United States.

Variety Growth and World Welfare

(with Christian Broda)
American Economic Review, May 2004.
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Why Countires Trade: Evidence from Firm-Level Data

(with Donald R. Davis)
The Journal of Japanese and International Economies, September 2003.
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The Factor Content of Trade?

(with Donald R. Davis)
Handbook of International Trade, James Harrigan, ed., New York: Blackwell, 2002.
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Abstract: Study of the factor content of trade has become a laboratory to test our ideas about how the key elements of endowments, production, absorption and trade fit together within a general equilibrium framework. Already a great deal of progress has been made in fitting these pieces together. Nevertheless, the existing research raises a great many questions that should help to focus empirical research in the coming years. Among the more pressing issues is a deeper consideration of the role of intermediates, the role of aggregation biases, and of differences in patterns of absorption. This work should provide a more substantial foundation for future policy work developed within a factor content framework.

Does Tokyo Matter? Increasing Returns and Regional Productivity

(with Donald R. Davis)
NBER Working Paper #8518, October 2001.
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Abstract: One account of spatial concentration focuses on productivity advantages arising from market size. We investigate this for forty regions of Japan. Our results identify important effects of a region’s own size, as well as cost linkages between producers and suppliers of inputs. Productivity links to a more general form of “market potential?or Marshall-Arrow-Romer externalities do not appear to be robust in our data. Landlocked status does not matter for productivity of regions in Japan. The effects we identify are economically quite important, accounting for a substantial portion of cross-regional productivity differences. A simple counterfactual shows that if economic activity were spread evenly over the forty regions of Japan, aggregate output would fall by nearly twenty percent.

Technological Superiority and the Losses From Migration

(with Donald R. Davis)
NBER Working Paper #8971, June 2002.
The Economist “Economics Focus” column of May 30, 2002 discusses this paper.
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Abstract: Two facts motivate this study. (1) The United States is the world’s most productive economy. (2) The US is the destination for a broad range of net factor inflows: unskilled labor, skilled labor, and capital. Indeed, these two facts may be strongly related: All factors seek to enter the US because of the US technological superiority. The literature on international factor flows rarely links these two phenomena, instead considering one-at-a-time analyses that stress issues of relative factor abundance. This is unfortunate, since the welfare calculations differ markedly. In a simple Ricardian framework, a country that experiences immigration of factors motivated by technological differences always loses from this migration relative to a free trade baseline, while the other country gains. We provide simple calculations suggesting that the magnitude of the losses for US natives may be quite large?$72 billion dollars per year or 0.8 percent of GDP.

Market Access, Economic Geography, and Comparative Advantage: An Empirical Assessment

(with Donald R. Davis)
Journal of International Economics [Lead Article], January 2003.
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Abstract: The increasing returns revolution in trade is incomplete in an important respect – there exists no compelling empirical demonstration of the role of increasing returns in determining production and trade structure. One reason is that trade patterns of the canonical increasing returns models are a consequence simply of specialization, which all theories permit. Krugman (1980) shows that increasing returns models with costs of trade – economic geography – do allow a simple test: home market effects of demand on production. Davis and Weinstein (1996) reject the simpleKrugman (1980) model on OECD data. Here we pair the model with a richer geography structure and find evidence of the importance of increasing returns, in combination with comparative advantage, in affecting OECD manufacturing production structure. The results underscore the importance of market access in implementing models of economic geography.

Bones, Bombs, and Break Points: The Geography of Economic Activity

(with Donald R. Davis)
American Economic Review [Lead Article], December 2002.
Paul Krugman’s column referring to this paper is available at the NYT, October 3, 2001.
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Abstract: We consider the distribution of economic activity within a country in light of three leading theories ?increasing returns, random growth, and locational fundamentals. To do so, we examine the distribution of regional population in Japan from the Stone Age to the modern era. We also consider the Allied bombing of Japanese cities in WWII as a shock to relative city sizes. Our results support a hybrid theory in which locational fundamentals establish the spatial pattern of relative regional densities, but increasing returns may help to determine the degree of spatial differentiation. One implication of our results is that even large temporary shocks to urban areas have no long-run impact on city size.

The Mystery of the Excess Trade (Balances)

(with Donald R. Davis)
American Economic Review, May 2002.
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What Role for Empirics in International Trade?

(with Donald R. Davis)
In Ronald Findlay, Lars Jonung, Mats Lundahl, eds., Bertil Ohlin: A Centennial Celebration, 1899-1999, Cambridge: MIT Press, 2002.
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Do Endowments Determine the Location of Production? Evidence from National and International Data?

(with Jeffrey Bernstein)
Journal of International Economics, February 2002.
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Abstract: Examining the relationship between factor endowments and production patterns using data from Japanese prefectures and from OECD nations, we find evidence of substantial production indeterminacy. Regressions of outputs on endowments yield prediction errors six to 30 times larger for goods traded relatively freely than for non-traded goods. We argue that a compelling explanation for these results is the existence of more goods than factors in the presence of trade costs. If so, regressions of trade or output on endowments have weak theoretical foundations. Furthermore, since errors are largest in data sets where trade costs are small, we explain why the common methodology of imputing trade barriers from regression residuals has produced counterintuitive results.

Trade and Growth: Import-Led or Export-Led? Evidence from Japan and Korea

(with Robert Z. Lawrence)
Rethinking the East Asia Miracle, Stiglitz, Joseph E. and Shahid Yusuf, eds. Oxford University Press, 2001.
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Abstract: It is commonly argued that Japanese trade protection has enabled the nurturing and development internationally competitive firms. The results in our paper suggest that when it comes to TFP growth, this view of Japan is seriously erroneous. We find that lower tariffs and higher import volumes would have been particularly beneficial for Japan during the period 1964 to 1973. Our results also lead us to question whether Japanese exports were a particularly important source of productivity growth. Our findings on Japan suggest that the salutary impact of imports stems more from their contribution to competition than to intermediate inputs. Furthermore our results indicate a reason for why imports are important. Greater imports of competing products spur innovation. Our results suggest that competitive pressures and potentially learning from foreign rivals are important conduits for growth. These channels are even more important as industries converge with the market leader. This suggests that further liberalization by Japan and other East Asian countries may result in future dynamic gains. Our results thus call the views of both the World Bank and the revisionists into question and provide support for those who advocate more liberal trade policies.

Evaluating Administrative Guidance and Cartels in Japan (1957-1988)

Japanese Law in context: Readings in Society, the Economy, and Politics, Milhaupt, Curtis J., Mark Remseyer, and Michael K. Young, eds. Harvard University Asia Center, 2001.
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Abstract: This paper uses cross-sectional and pooled time series data to examine the impact of administrative guidance and cartels in Japan. In general, government-organized cartels appear to have caused only small changes in prices and had no impact on sectoral margins. The lack of a stronger relationship between cartels and margins probably reflects either the difficulty of organizing cartels or the tendency of cartelized firms to compete away rents through competition through quality. It is also possible that Japanese cartels had little impact on prices because efforts to reduce costs offset incentives to raise prices.

An Account of Global Factor Trade

(with Donald R. Davis)
American Economic Review, December 2001.
historical
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Abstract: A half-century of empirical work attempting to predict the factor content of trade in goods has failed to bring theory and data into congruence. Our study shows how the Heckscher-Ohlin-Vanek theory, when modified to permit technical differences, a breakdown in factor price equalization, the existence of non-traded goods, and costs of trade, is consistent with data from ten OECD countries and a rest-of-world aggregate.

Do Factor Endowments Matter for North-North Trade?

(with Donald R. Davis)
NBER Working Paper #8516, October 2001.
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Abstract: The dominant paradigm of world trade patterns posits two principal features. Trade between North and South arises due to traditional comparative advantage, largely determined by differences in endowment patterns. Trade within the North, much of it intra-industry trade, is based on economies of scale and product differentiation. The paradigm specifically denies an important role for endowment differences in determining North-North trade. This paper provides the first sound empirical examination of this question. We demonstrate that trade in factor services among countries of the North is systematically related to endowment differences and large in economic magnitude. Intra-industry trade, rather than being a puzzle for a factor endowments theory, is instead the conduit for a great deal of this factor service trade.

Market Size, Linkages, and Productivity: A Study of Japanese Regions

(with Donald R. Davis)
NBER Working Paper #8518, October 2001.
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Abstract: One account of spatial concentration focuses on productivity advantages arising from market size. We investigate this for forty regions of Japan. Our results identify important effects of a region’s own size, as well as cost linkages between producers and suppliers of inputs. Productivity links to a more general form of “market potential?or Marshall-Arrow-Romer externalities do not appear to be robust in our data. Landlocked status does not matter for productivity of regions in Japan. The effects we identify are economically quite important, accounting for a substantial portion of cross-regional productivity differences. A simple counterfactual shows that if economic activity were spread evenly over the forty regions of Japan, aggregate output would fall by nearly twenty percent.

International Trade as an ‘Integrated Equilibrium’: New Perspectives

(with Donald R. Davis)
American Economic Review, May 2000.
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Abstract: The concept of the ‘Integrated Equilibrium’ has played an important role in the development of the theory of international trade. In spite of the fact that all observers understand that it is not literally a description of the world that we live in, approaches based on this concept have been very influential in discussion of real world policies. In this paper, we discuss some of the key empirical limitations of this concept and suggest directions that future empirical and theoretical work needs to go once we recognize the limits of integrated equilibrium thinking.

Economic Geography and Regional Production Structure: An Empirical Investigation

(with Donald R. Davis)
European Economic Review, February 1999.
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Abstract: There are two principal theories of why countries or regions trade: comparative advantage and increasing returns to scale. Yet there is virtually no empirical work that assesses the relative importance of these two theories in accounting for production structure and trade. We use a framework that nests an increasing returns model of economic geography featuring “home market effects” with that of Heckscher-Ohlin. We employ these trade models to account for the structure of regional production in Japan. We find support for the existence of economic geography effects in eight of nineteen manufacturing sectors, including such important ones as transportation equipment, iron and steel, electrical machinery, and chemicals. Moreover, we find that these effects are economically very significant. The latter contrasts with the results of Davis and Weinstein (1996), which found scant economic significance of economic geography for the structure of OECD production. We conclude that while economic geography may explain little about the international structure of production, it is very important for understanding the regional structure of production.

Using International and Japanese Regional Data to Determine When the Factor Abundance Theory of Trade Works

(with Donald R. Davis, Scott Bradford, and Kazushige Shimpo)
American Economic Review, June 1997.
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Abstract: The Heckscher-Ohlin-Vanek (HOV) model of factor service trade is a mainstay of international economics. Empirically, though, it is aflop.This warrants a new approach. We test the HOV model with international and Japanese regional data. The strict HOV model performs poorly because it cannot explain the international location of production. Restricting the sample to Japanese regions provides no help, inter alia giving rise to what Trefler (1995) calls the “mystery of the missing trade.” However, when we relax the assumption of universal factor price equalization, results improve dramatically. In sum the HOV model performs remarkably well.

Empirical Tests of the Factor Abundance Theory: What Do They Tell Us?

(with Donald R. Davis)
Published in the Eastern Economic Journal, Fall 1996.

FDI and Keiretsu: Rethinking US and Japanese Policy

Published in Feenstra, R. ed., Effects of U.S. Trade Protection and Promotion Policies, Chicago: University of Chicago Press, 1997.
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Abstract: This paper focuses on two issues. First, a reexamination of the data on the level of foreign direct investment (FDI) in Japan suggests that foreign firms sell five to six times more in Japan than is commonly believed. Previous studies severely underestimated the stock of FDI in Japan due to poor data. Second, after finding that even after adjusting for various factors the level of FDI in Japan is still low, the paper explores explanations for this phenomenon. A second main conclusion is that government tax and financial policy continues to inhibit foreign takeovers through the promotion of stable shareholding.

United We Stand: Enterprise Unions and Firms in Japan

Journal of the Japanese and International Economies, 8, pp. 53-71, 1994.

Abstract: Most Japanese workers in large firms are members of firm-based enterprise unions while workers in the United States, if organized at all, tend to be members of trade or industrial unions. This paper analyzes how differences in union structure and membership can affect firm behavior in a Pareto optimal contracting framework. The findings are that oligopolistic firms with enterprise unions will tend to hire excessive amounts of labor. Furthermore, it is shown that by organizing as an enterprise union and firm, the firm and its employees can be made better off relative to not being organized at all.