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Week 2 notes

by: Erica Evans

Week 2 notes Polisci110G

Erica Evans
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Notes from 1/12 and 1/14
Governing the Global Economy
Kenneth Scheve
Class Notes
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This 10 page Class Notes was uploaded by Erica Evans on Thursday January 14, 2016. The Class Notes belongs to Polisci110G at Stanford University taught by Kenneth Scheve in Fall 2016. Since its upload, it has received 14 views. For similar materials see Governing the Global Economy in Political Science at Stanford University.

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Date Created: 01/14/16
Polisci110G   Class  3   1/12/2015     Voting  history:  US     • Voting  Unity  Score:  Dems  and  Reps  in  House  of  Representatives.    In  1980’s,   parties  become  more  unified  among  themselves.     • Late  1990’s,  more  unity  in  Trade  votes  than  there  was  in  the  60’s  and  70’s     • Why  might  this  be  the  case?         Terminology:     • Factor  of  production:  labor,  capital,  land,  anything  that  goes  into  producing  a   good   • Sector  of  Production:  basically  means  industry,  like  the  automobile  sector     • Factor  Mobility:  How  easy  it  is  for  factors  of  production  to  move  from  one   sector  of  the  economy  to  the  other.     • High  mobility  example:  A  high  skilled  computer  programmer  can  move   across  industries  relatively  easily.  Someone  skilled  works  however  may  have   a  hard  time  changing  industries.     • Low  mobility  example:  Over  a  short  time,  a  factory  that  is  set  up  to  make   computers  will  require  high  costs  to  be  changed  to  a  car  factory     • Factor-­‐intensiveness  of  production:    Are  skilled  or  unskilled  workers  used   more?  For  shoes,  unskilled  workers  are  used  more  than  for  computers.     • (Relative)  Factor  abundance:  some  countries  have  more  factors  than  others.   Some  countries  have  more  land.  The  U.S.  has  more  land  than  Belgium.       A  Model   • Heckscher-­‐Ohlin  Model:  with  two  goods  and  two  factors,  each  country  will   export  the  good  that  uses  intensively  the  factor  of  production  it  has  in   abundance  and  will  import  the  other  good     • Comparative  advantage  depends  on  relative  abundance  of  factors  of   production.     • Assumptions:  Two  countries:  home  and  foreign.  Two  goods:  computers  and   shoes.  High  inter-­‐sectoral  factor  mobility,  so  both  factors  can  move  freely   between  industries.       • Shoe  production  is  more  labor  intensive     • Foreign  is  labor  abundant,  meaning  its  aggregate  low  skill  labor-­‐human   capital  ratio  is  larger  than  Home.  Home  has  more  high  human  capital.     • Shoes  and  Computers  can  be  traded,  but  there  is  no  immigration.  Technology   is  used  to  produce  goods  identical  across  countries.     • Note:  countries  are  different  in  real  life,  and  produce  different  goods.  In  this   model,  the  only  thing  different  is  their  factor  endowments.  Their  consumer   tastes  are  also  exactly  the  same  in  this  model.     • Because  the  US  has  more  high-­‐skilled  workers,  when  it  puts  all  its  efforts  into   making  computers,  it  can  make  a  lot,  a  lot  more  than  Brazil  can!  If  Brazil  puts   all  its  efforts  into  making  shoes,  it  can  make  more  shoes  than  the  US  can.     • Trade  moves  us  to  higher  indifference  curve…  but  how  does  production   move?  The  world  equilibrium  is  set  at  a  new  price.   • How  much  is  exported:  determined  by  the  price  and  demand  in  the  home   country.       Example:     • Japan  and  Vietnam:  Vietnam  has  more  low-­‐skilled  workers.  Vietnam  will   export  textiles  and  import  cotton  wheels.  This  is  not  a  mystery!  Who  is   exporting  what  is  driven  by  the  relative  abundance  of  factors  of  production   across  countries.       What  are  the  implications  of  this  model  for  identifying  winners  and  losers   across  trade?     • Stolpher-­‐Samuelson  Model!  In  the  long  run,  this  kind  of  trade  results  in  real   earning  increases  for  skilled  workers.  This  results  in  a  real  earnings  decrease   for  unskilled  workers.  (in  the  Home  example).  The  opposite  is  true  for  the   foreign  country.     • See  the  Alt  and  Giligan  article     • The  price  of  computers  goes  up,  production  moves  to  computers  and  leaves   shoes.  This  increases  the  relative  demand  for  skilled  workers.  This  shift  in   relative  demand  will  raise  the  earnings  relative  to  unskilled  workers.  The   skilled  workers  will  have  more  money  than  the  unskilled.  This  is  a  multiplier   effect.  The  increase  in  their  earnings  is  going  to  compensate  for  the  fact  that   the  price  of  computers  is  going  up  too.     • Note:  The  price  of  computers  is  going  up  because  we  are  opening  up  to  trade   –  and  the  world  price  ends  up  between  the  foreign  price,  which  was  very   high  and  the  home  price,  which  was  very  low.     • We  would  expect  unskilled  workers  not  to  like  international  trade  and   support  trade  protection.  People  who  are  educated  will  be  unlikely  to   support  trade  protection  at  Home.  The  opposite  will  be  true  in  Foreign.     • Possible  problem:  A  country  like  Brazil  has  more  unskilled  workers,  but  is   still  a  middle-­‐income  country.  They  do  have  a  lot  of  skilled  workers  too.  So   they  may  vote  differently.       H-­‐O  Model  and  Public  Opinion:   • The  US  is  well  endowed  in  high  human  capital.  We  expect  a  negative   correlation:  As  we  increase  education,  less  likely  to  support  trade  regulation.     Countries  like  Norway,  Sweden  are  similar.     • But  countries  like  Bangladesh:  There  is  NOT  a  strong  correlation  between   education  and  being  likely  to  support  trade  regulation.     • HO  model  predicts  winners  and  losers  –  assumes  high  inter-­‐sectoral  factor   mobility.  But  let’s  revisit  that  assumption.  This  is  not  realistic.  Sometimes   factors  are  really  specific.       Specific-­‐Factors  Model:     • When  the  price  of  computers  goes  up,  the  winners  are  everyone  in  the   computer  industry,  when  the  price  of  shoes  goes  down,  the  losers  are   everyone  in  the  shoe  industry.    (Not  separation  between  skilled  and   unskilled)     • About  industries,  not  factors       When  is  one  model  better  than  the  other?     • Think  about  intersectoral  mobility  and  technologies  of  production  etc.     • KNOW  THIS  SLIDE!  Comparison  between  Hecksher-­‐Ohlin  and  Specific-­‐ Factors  models.     • HO:  intersectoral  mobility  is  high  SF:  intersectoral  factor  mobility  is  low.     • HO:  Technologies  of  production  are  the  same  SF:  technologies  are  different     • ….  (review  the  rest  of  this  slide)       Back  to  the  original  question:  Why  was  there  more  unity  between  democrats   and  republicans  (respectively)  in  the  80’s  and  90’s  in  terms  of  trade  law?     • Trade  politics:  republicans  vote  against  trade  and  some  vote  for  it.   Democrats:  Some  vote  for  trade  and  some  vote  against  it.    Members  of   Congress  are  from  different  regions  and  the  people  who  elect  them  want   different  things.  They  also  have  special  interests:  campaign  contributions   from  the  specific  industries.       • In  the  60’s  and  70’s,  people  were  voting  differently  because  trade  politics   was  all  about  special  interest  groups.  It  was  a  world  where  there  was  low   intersectoral  mobility.    A  lot  of  people  were  stuck  in  the  same  industry   because  the  cost  of  moving  industries  was  very  high.  Special  industry  groups   lobbying  had  a  huge  effect  on  trade  votes.     • Later,  there  was  more  party  unity  because  there  was  more  factor  mobility.  It   doesn’t  matter  what  industry,  now  free  trade  is  good  for  skilled  workers,   protection  is  good  for  unskilled  workers.       th What  explains  US  trade  liberalization  in  the  mid-­‐20  century?     • In  the  mid-­‐1930’s  trade  liberalization     • Very  dramatic  liberalization  after  WWII   • What  did  trade  politics  look  like  before  the  1930’s?  It  was  a  constant  back   and  forth  between  democrats  (party  of  capital-­‐owners,  supported  free-­‐trade)   and  republican  (party  of  farmers,  were  protectionist)  raising  and  lowering   tariffs.     • After  1932,  democrats  won  the  election,  policy  gets  more  and  more  liberal,   even  when  republicans  return  to  power.  Why?     • In  1934  -­‐-­‐  RTAA  Reciprocal  Trade  agreements  Act  of  1934.  Mandated  that  the   president  negotiate  reciprocal  trade  agreements  with  their  countries  that   reduce  tariffs  up  to  50%  in  exchange  for  access  to  foreign  markets.     • Congress  just  has  to  approve  by  a  majority.     • Leads  to  more  liberal  U.S.  policy  because  the  president  decides.  There  are   concentrated  rather  than  confused  benefits.     • President  ends  congressional  logrolling.  President  has  incentive  to  weigh  the   benefits  for  the  entire  country,  rather  than  disparate  regions.  This  puts  more   weight  on  the  benefits  for  consumers.     • Problems:  there  wasn’t  a  universal  model  in  the  first  place.     • There  is  little  evidence  of  learning  on  the  part  of  legislators.  Among  225   members  of  Congress  who  voted  on  the  Smoot-­‐Hawley  and  RTAA,  only  9   changed  their  position.     • Also,  the  president  is  not  necessarily  more  liberal  than  Congress.  Republican   presidents  are  routinely  more  protectionist.       Another  idea:     • RTAA  is  a  new  institution  for  policymaking  in  which  Congress  delegates   authority  for  trade  policymaking  and  this  leads  to  more  liberal  US  policy.     • A  RECIPROCAL  trade  agreement  means  that  these  agreements  are  more   permanent.       Reciprocity:     • Ordinarily  export  interests  are  not  well  organized  for  tariff  politics.     • Exporters  share  an  interest  for  lower  tariffs  to  avoid  closure  in  foreign   markets  and  to  lower  input  costs  but  these  benefits  are  uncertain  and   dispersed  widely  among  all  exporters.     • RTAA  made  tariff  setting  explicitly  reciprocal     • We  are  going  to  get  lower  tariffs  out  of  other  countries!     • Assume  that  everyone  in  the  US  wants  low  tariffs  in  other  countries,  but  we   had  other  preferences  about  our  own  tariff  policy.     • There  is  a  section  of  overlapping  policy,  which  makes  both  the  democrats   and  republicans  happier.     • After  1930’s  opened  up  a  range  of  outcomes     • It  lasts  because  it  is  a  bigger  shift  in  policy,  shifting  back  becomes  harder.   Increasing  trade  made  exporters  more  organized  over  trade  policy.     • The  RTAA  is  just  a  regular  piece  of  legislation,  so  they  could  have  killed  it,  but   they  didn’t!  This  suggests  that  the  institution  created  by  the  RTAA  was   possibly  less  important  than  changes  in  political  constituencies.     • Republicans  started  liking  free  trade  –  their  constituencies  shifted  their   interests  in  a  free  trade  direction.  People  in  the  South  and  the  West  started   voting  for  Republicans  more,  and  they  support  free  trade.  But  people  in  the   Northeast  also  changed  their  preferences.     • Over  time,  you  get  a  shifting  of  U.S.  comparative  advantage  in  capital-­‐ intensive  products  –  a  shifting  of  free  trade  preferences  among  democrats.     • Overall,  there  is  more  consensus  on  free  trade.     • Institutions  matter!  But  remember  that  these  institutions  are  selected  by   politicians  and  people.  So  always  think  about  how  peoples’  preferences  affect   the  implementation  of  these  policies!         Polisci110G   Class  4   1/14/2016     Announcements:     Case  Study  –  1)  talk  to  your  friends,  don’t  do  this  by  yourself.  2)  Write  a   recommendation  on  your  own.  3-­‐4  pages.  Analyze  both  the  economic  and  political   consequences.    Use  some  empirical  evidence  as  well  to  make  your  recommendation   more  persuasive.         Trade  in  International  Institutions   • Western  leaders  plan  post-­‐war  economic  international  order     • Economic  depression  and  World  War  II  were  catastrophic     • Disagreement  within  the  Roosevelt  administration  and  among  others  about   world  economy   • Eventually  they  decide:  we  need  freer  trade  and  the  recovery  of  international   investment     • This  was  led  by  Cordell  Hull  (Secretary  of  State),  a  southern  democrat   (export-­‐oriented)     • Hull  believed  that  trade  has  security  benefits  –  protectionism  leads  to  war     • Countries  that  have  trade  agreements  treat  each  other  peacefully  as  allies     • “American  Internationalism”  since  Wilson,  but  we  still  had  protectionist   trade  policies  for  a  long  time.    The  height  of  protectionism  was  the  Smoot-­‐ Hawley  Tariff  in  1930.   th • Late  19  century,  Britain  was  leading  in  liberalization.     • Reaction  to  the  Great  Depression:  people  blamed  protectionism  for   exasperating  the  depression.  (Economic  historians  don’t  think  protectionism   was  the  cause,  but  agree  that  it  could  have  made  it  a  bit  worse)     • The  U.S.  and  Britain  decide  we  should  have  freer  trade       How  do  we  get  freer  trade?     • Set  up  International  Institution:     • 3  pillars  of  reform:     • Monetary  cooperation  à  IMF   • Increase  investment  à  world  bank   • Freer  trade  à  which  institution?  They  were  not  able  to  come  to  an   agreement,  negotiations  continued.     • 1948:  established  a  charter  for  an  “International  Trade  Organization”   • But  this  never  came  into  being.  They  created  a  substitute:  “general   agreement  on  tariffs  and  trade”  for  the  interim  time  before  the  ITO  could   come  into  being.  This  was  an  agreement  to  get  freer  trade  going.  These   agreements  were  negotiated  under  the  principal  of  reciprocal  mutual   advantage.     • Most  Favored  Nation  also  applied  to  all       GATT/WTO  (essentially  the  same  organization)     • A  set  of  principles  and  rules     • An  intergovernmental  bargaining  process  and  a  dispute  settlement  process   (kind  of  a  court  for  when  people  cheat).     • 1)  Free  trade  is  good     •  Winners  could  compensate  losers     • 2)  Nondiscrimination     • Most  favored  nation  –  treat  all  countries  as  well  as  your  favorite  trading   partner     • National  treatment  –  prohibits  favoring  domestic  firms     Other  functions:     • Regional  trade  arrangements  (Article  24)     • Free  trade  area  (NAFTA  or  customs  union  (EU)     • Generalized  System  of  Preferences  (from  1960’s)     Other  articles:       • Article  6:  dumping  is  bad.  Process  to  undo  this  unfair  advantage.  Ex:  “China  is   dumping  a  product  on  the  US  market.  They  are  selling  a  good  below  the  cost,   or  below  the  price  it  sells  in  its  own  market.”     • Article  11:  prohibits  quotas  (quantitative  restrictions)     • Article  12:  an  exception  to  article  11  (when  countries  have  balance  of   payment  problems)     • Article  18:  if  a  country  has  an  infant  industry  case,  they  can  protect  this.       Intergovernmental  Bargaining  Process:     • After  establishment  of  GATT,  there  are  negotiating  rounds  –  adding  new   members,  reducing  tariffs,  moving  into  new  areas  related  to  trade  protection   (like  addressing  safety  regulations  or  health  regulations  that  might  favor   domestic  producers  over  foreign  producers.)  Address  intellectual  property   rights.  These  rounds  happen  periodically  1947-­‐2001.     • In  1960’s  35%  tariff  reduction.  Also  1970’s  more  reduction.     • 1986-­‐1994:  most  important  round.  Created  the  WTO,  which  changed  the   rules  of  dispute  settlement.  It  includes  agriculture,  clothing  and  textiles   which  had  not  been  included  before  (a  previous  reason  for  criticism,  because   these  are  things  undeveloped  countries  produce)   • At  the  end  of  this  round,  tariffs  were  extremely  low:  basically  free  trade  in   developed  countries.       WTO  reality:     • Relatively  weak  organization.  Basically  just  a  means  for  countries  to  get   together  and  decide  things.  The  power  lies  with  member  governments.   Operates  on  consensus.     • WTO  has  a  super  small  budget.     • If  a  country  decides  to  violate  a  rule,  nothing  happens.  There  is  no  enforcing   power.  Countries  can  remove  privileges  or  punish  a  country  though.     Dispute  Settlement:     • How  the  GATT  was  and  how  it  is  now:     • A  funny  court  –  someone  accuses  you  and  you  can  veto  proceeding  with  the   trial  …  so  not  super  effective.     • 1)  Request  for  consultation     • 2)  Request  a  panel  (judges  to  rule  on  the  case)     • 3)  Panel  publishes  ruling,  allows  for  retaliation     • BUT  –  the  country  could  veto  at  any  point  in  the  process.     • (So  this  is  how  it  used  to  be.  They  fixed  this  under  the  WTO)     • Now  countries  don’t  have  to  comply  at  the  end,  but  they  can’t  veto  the   process     • Still,  countries  only  tend  to  complain  if  their  case  is  really  strong     • WTO  provides  deterrent  effect  though  –  because  it  is  a  means  for  pointing   out  cheating     • This  allows  governments  to  legally  punish  each  other.  You  can  legally  raise   tariffs  etc.       What  is  the  point  of  the  WTO?     • Does  it  increase  trade?         -­‐  Well,  one  argument  is  that  countries  decide  they  want  to  liberalize       and  then  they  join  these  organizations.  The  institution  has  no  direct  effect  on     their  behavior.     • Why  don’t  we  let  everyone’s  domestic  governments  decide  on  their  own?     • What  are  the  benefits  of  joining?     -­‐ Establish  a  community  with  a  common  purpose     -­‐ Information  –  the  dispute  settlement  mechanism  can  determine   whether  countries  met  their  obligations.     -­‐ International  externalities  –  Governments  can  weigh  the  costs  and   benefits  of  their  domestic  situation  and  decide  a  trade  policy.  But   there  could  be  externalities  that  suggest  problems  with  trade   protection  aren’t  just  about  what  happens  within  one  economy,   but  the  way  countries  interact  effects  the  outcome.     -­‐ Political  externality  –  international  institutions  help  countries   cooperate  in  the  presence  of  political  pressures.  Example:  if  each   country  can  liberalize  and  protect:  this  is  like  a  cooperation   problem  (prisoner’s  dilemma).  It’s  best  if  both  liberalize,  but  if  one   liberalizes  and  the  other  protects,  this  puts  the  liberalized  country   at  a  disadvantage  …  so  both  countries  may  choose  to  protect  to   avoid  this  worst  outcome.     -­‐ ^WTO  can  help  with  this  cooperation  problem.  But  the  institution   is  not  necessarily  required.  You  don’t  really  NEED  the  WTO  for   cooperation.     -­‐ However  it  helps  by  ensuring  indefinite  repeated  interaction.  They   may  engage  in  tit-­‐for-­‐tat  strategy,  but  the  GATT/WTO  is  based  on   idea  for  reciprocal  tariff  reductions,  so  they  are  bargaining  over   reciprocal  concessions  on  tariffs  and  not  getting  stuck  in  a  cycle  of   raising  tariffs  to  punish  each  other.       Terms  of  trade  externalities:   • Beggar-­‐thy-­‐neighbor  policy:  only  applies  to  large  countries.  Distinguish   between  small  and  large  countries.  When  large  countries  can  influence  the   world  price  –  the  wedge  b/w  world  price  and  domestic  price  –  the  tariff  is   that  wedge  in  a  small  country.  The  big  country  pushes  that  wedge  down,  so   the  small  countries  bears  the  cost  of  that  tariff.     • Political  leaders  have  to  weigh  efficiency  costs  of  tariffs  with  political   consequences  of  the  tariff  (not  much  an  international  institution  can  do  to   change  this).     • But  the  effect  on  world  price  is  an  international  effect.  This  is  a  terms  of  trade   story  à  this  leads  to  another  prisoner’s  dilemma.    Which  the  WTO  can   facilitate  because  it  helps  cooperation.     • There  is  empirical  evidence  that  country’s  tariffs  can  affect  their  terms  of   trade  even  for  medium-­‐sized  countries  like  Mexico.    They  are  more  likely  to   set  tariffs  higher  in  markets  in  which  they  are  more  likely  to  be  able  to   influence  the  world  price.  Incentives  to  shift  costs.       Domestic  Commitment:     • Countries  would  like  to  liberalize  trade  because  it  is  good  for  the  country,  but   it  is  hard  not  to  listen  to  lobbyists  in  their  country.     • Being  part  of  the  WTO  lets  them  commit  to  free  trade.     • Why  would  governments  want  to  do  this  if  listening  to  lobbyists  helps   politicians  get  elected?  (a  key  puzzle!)     • Maggi  and  Rodriguez-­‐Clare  –  lobbies  pay  governments  of  small  countries  for   inefficiencies  that  protection  causes  in  the  short  run,  but  they  don’t  get   rewarded  for  over  investment  in  uncompetitive  industries.  Government  can   be  made  better  off  by  ending  the  lobbying  process.       Political  Hold-­‐up:     • Example:  US  and  Hawaii,  before  Hawaii  was  a  state.  The  US  wanted  to   promise  Hawaii  they  would  give  them  special  deal  on  sugar  tariffs,  so  Hawaii   could  sell  sugar  to  the  US.  Bilateral  agreement.  Hawaii  was  worried  –  if  we   invest  in  sugar  industry  and  US  raises  tariffs,  we  are  screwed.  The  agreement   was  a  3-­‐5  year  agreement.  When  the  3-­‐5  years  is  up,  US  says  they  want  to   build  a  base  in  Pearl  Harbor.  They  used  raising  tariffs  as  leverage  to  impose   their  political  will  on  Hawaii  –  like  a  threat.  This  is  a  political  hold-­‐up   problem.     • The  WTO  helps  avoid  this  commitment  problem.     • China-­‐  US  trade  relations  before  China  joined  WTO.  We  would  hold-­‐up  China   and  demand  that  they  improve  human  rights  or  we  would  remove  trade   privileges.  Then  China  joined  WTO  which  creates  norms  that  you  can’t  use   trade  policies  to  get  what  you  want  politically  –  even  if  it’s  a  good  thing  like   human  rights.     • US-­‐China  MFN  debate  –  there  were  super  frequent  threats.  Debate  over   whether  China  should  become  a  permanent  MFN  member.  There  were   benefits  of  having  China  in  the  WTO,  but  some  people  didn’t  want  to  give  up   the  option  of  having  this  political  leverage.   • Countries  know  that  if  they  violate  this,  others  may  violate  it  too,  in  a   negative  way.  WTO  makes  violations  by  larger  countries  more  costly.  Hawaii   could  not  protect  itself  from  being  pushed  around  by  the  US,  but  the  WTO  can   help  with  things  like  this.  Prevents  big  countries  from  exploiting  small   countries.       Possibility  that  WTO  doesn’t  do  anything:     • The  empirical  literature  as  I  see  it:     • At  the  end  of  WWII,  Western  allies  wanted  to  support  free  trade.  We  see  now   that  there  is  a  lot  more  free  trade  since  this  time.  Trade  has  grown  at  a  rate   must  fast  than  the  growth  of  the  world  economy  –  suggests  that  GATT  is  a   success.     • Trade  protection  among  members  falling  at  about  40%  on  average  –  another   indication  of  success.     • But  this  may  have  just  been  caused  by  unilateral  policy  choices.  It  is  really   difficult  to  establish  a  causal  effect  on  GATT/WTO  and  free  trade.  There  are   all  kinds  of  things  changing  in  these  countries  and  these  can  account  for   changes  in  patterns  we  observe.     • Other  empirical  evidence:     -­‐ Countries  getting  richer,  transportation  costs,  etc.  Even  when  you   control  for  these  factors,  there  is  still  evidence  that  free  trade   increases  with  WTO  membership.     -­‐ Effects  have  declined  as  more  countries  joined  however     -­‐ Developed  countries  trade  more  with  each  other  when  they  join,   but  developing  countries  do  not.  (Remember  that  agriculture  and   textiles  were  left  out)     -­‐ Could  be  all  selection  –  institution  is  just  a  reflection  of  countries   preferences    


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