Program and working group meetings.

• Position: Company overview

International Trade and Investment

The NBER's Program on International Trade and Investment met in Cambridge on March 30 and 31. NBER Faculty Research Fellow Lee G. Branstetter of Carnegie Mellon University organized the program. These papers were discussed:

Devashish Mitra, Syracuse University and NBER, and Priya Ranjan, University of California, Irvine, "Offshoring and Unemployment"

Andres Rodriguez-Clare, Pennsylvania State University and NBER, "Offshoring in a Ricardian World"

Nikolaj Malchow-Moller and Bertel Schjerning, CEBR, and James R. Markusen, University of Colorado, Boulder and NBER, "Foreign Firms, Domestic Wages"

Richard Baldwin, University of Geneva and NBER, and James Harrigan, Federal Reserve Bank of New York and NBER, "Zeros, Quality, and Space: Trade Theory and Trade Evidence"

Alla Lileeva, York University, and Daniel Trefler, University of Toronto and NBER, "Does Improved Market Access Raise Plant-Level Productivity?"

Jiandong Ju, University of Oklahoma, and Shang-jin Wei, International Monetary Fund and NBER, "Domestic Institutions and the Bypass Effect of International Capital Flows"

Wolfgang Keller and Carol H. Shiue, University of Colorado, Boulder and NBER, "Tariffs, Trains, and Trade: The Role of Institutions versus Technology in the Expansion of Markets"

In order to study the impact of offshoring on sectoral and economy-wide rates of unemployment, Mitra and Ranjan construct a two-sector general equilibrium model in which labor is mobile across the sectors and unemployment is caused by search frictions. They find that, contrary to general perception, wages increase and sectoral unemployment declines because of offshoring. This result can be understood to arise from the productivity enhancing (cost reducing) effect of offshoring. If the search cost is identical in the two sectors, or even if the search cost is higher in the sector that experiences offshoring, the economy-wide rate of unemployment decreases. The researchers also find multiple equilibrium outcomes in the extent of offshoring and therefore, in the unemployment rate. Furthermore, a firm can increase its domestic employment through offshoring. Also, such a firm's domestic employment can be higher than that of a firm choosing to remain fully domestic. When they modify the model to disallow intersectoral labor mobility, the negative terms-of-trade effect on the sector in which firms offshore some of their production activity becomes stronger. In such a case, it is possible for this effect to offset the positive productivity effect, and to result in a rise in unemployment in that sector. In the other sector, offshoring has a much stronger unemployment reducing effect in the absence of intersectoral labor mobility than in the presence of it. Finally, allowing for an endogenous number of varieties in the offshoring sector provides an additional indirect channel through which sectoral unemployment goes down.

Falling costs of coordination and communication have allowed firms in rich countries to fragment their production process and offshore an increasing share of the value chain to low-wage countries. Popular discussions about the aggregate impact of this phenomenon on rich countries have stressed either a (positive) productivity effect associated with increased gains from trade or a (negative) terms-of-trade effect linked with the vanishing effect of distance on wages. Rodriguez-Clare proposes a Ricardian model where both of these effects are present. He analyzes the effects of increased fragmentation and offshoring in the short run and in the long run (when technology levels are endogenous). The short-run analysis shows that when fragmentation is sufficiently high, further increases in fragmentation lead to a deterioration (improvement) in the real wage in the rich (poor) country. But the long-run analysis reveals that these effects may be reversed as countries adjust their research efforts in response to increased offshoring. In particular, the rich country always gains from increased fragmentation in the long run, whereas poor countries see their static gains partially eroded by a decline in their research efforts.

Foreign-owned firms are often hypothesized to generate productivity "spillovers" to the host country, but both theoretical micro-foundations and empirical evidence for this are limited. Malchow-Moller, Markusen, and Schjerning develop a heterogeneous-firm model in which ex-ante identical workers learn from their employers in proportion to the firm's productivity. Foreign-owned firms have, on average, higher productivity in equilibrium because of entry costs, which means that low-productivity foreign firms cannot enter. Foreign firms have higher wage growth and, with some exceptions, pay higher average wages, but not when compared to similarly large domestic firms. The empirical implications of the model are tested on matched employer-employee data from Denmark. The authors find considerable evidence of higher wages and wage growth in foreign-owned firms; these effects are significantly reduced but generally not eliminated when controlling for firm size. The results are largely consistent with their model. Furthermore, productivity transfers appear to be important, as experience from foreign-owned and large firms is clearly beneficial for subsequent wages and self-employment earnings.

Product-level data on bilateral U.S. exports exhibit two strong patterns. First, most potential export flows are not present and the incidence of these "export zeros" is strongly correlated with distance and importing country size. Second, export unit values are positively related to distance. Baldwin and Harrigan show that every well-known multi-good general equilibrium trade model is inconsistent with at least some of these facts. They also offer direct statistical evidence of the importance of trade costs in explaining zeros, using the long-term decline in the cost of air shipment to identify a difference-in-differences estimator. To match these facts, they propose a new version of the heterogeneous-firms trade model pioneered by Melitz (2003). In their model, high quality firms are the most competitive, with heterogeneous quality increasing with firms' heterogeneous cost.

Lileeva and Trefler weigh into the debate about whether rising productivity is ever a consequence, rather than a cause, of exporting. They argue that improved market access should induce plants to invest in productivity-enhancing activities. Further, improved market access should not induce all plants to invest, only those that expect the largest returns to such investments. That is, there should be heterogeneous responses to improved market access. Using data on plant-specific tariff concessions afforded Canadian plants under the Canada-U.S. Free Trade Agreement as an instrument for exporting, the researchers compare the performance of new (post-Agreement) exporters with non-exporters. They find that relative to non-exporters, new exporters experienced higher rates of labor productivity growth and higher rates of investment in product development and advanced manufacturingtechnologies.

Why does FDI travel from rich to poor countries but non-FDI not do so? Could financial and property rights institutions play different roles in understanding capital flows? Unbundling both institutions and capital flows, Ju and Wei propose a simple model for studying the relationship between various domestic institutions--financial system, corporate governance, and property rights protection--and patterns of international capital flows. They describe conditions under which inefficient financial systems and poor corporate governance in a country may be bypassed by two-way capital flows in which domestic savings would leave the country in the form of outflows of financial capital but domestic investment would take place via the inflows of foreign direct investment. In this framework, financial, and property rights institutions can have different effects on capital flows.

Keller and Shiue study the emergence of the increasingly unified commodity market in Europe in the nineteenth century. During this period, there were major institutional changes in the form of currency agreements and the Zollverein customs liberalizations, as well as transport cost reductions in the form of building railways. In assessing the relative importance of these factors, the setting here has a number of clear advantages over existing studies. For one, almost all economies in this sample experienced changes over the course of the nineteenth century. Currency or trade arrangements did not exist between any of the states in the early 1800s, whereas by the closing years of the nineteenth century they existed between all German states. Similarly, railroads did not exist before the 1830s, whereas by the end of the century trains had arrived almost everywhere in the sample. The authors study changes in market integration in terms of the spatial dispersion of grain prices in 68 markets with about 10,000 observations, located in five different countries and fifteen different German states. They find that the emergence of integrated commodity markets in nineteenth century Europe is, in a major part, attributable to the transportation revolution in the form of the railways. Over a relatively short time horizon, the effect of customs liberalization is comparable in size, whereas in the long run, the impact of railways is larger. The researchers do not estimate a significant effect of currency agreements on market integration. Their results suggest that as significant as institutional factors were for the expansion of markets, technology factors may have been even more important.

Education Program Meeting

The NBER's Education Program met in Cambridge on April 26. Program Director Caroline M. Hoxby of Harvard University organized the meeting. These papers were discussed:

Amalia R. Miller, University of...