Impullitti, Giammario

Licandro, Omar

LSE Research Online

We	may	be	underestimating	the	gains	fromglobalisationRecent	research	has	shown	that	international	trade	can	lead	to	job	losses	in	some	sectors	and	areas	within	a	countryand	gains	in	others,	and	it	can	also	affect	the	countrywide	level	of	wage	inequality	across	workers.	These	side	effectsof	globalisation	have	fuelled	populist	responses	in	Europe	and	the	United	States,	with	political	leaders	promising	tostop	global	market	forces	and	re-empower	the	nation-state.	If	the	gains	from	trade	are	small,	is	it	worth	facing	thedistributional	consequences	of	globalisation	and	the	political	backlash	associated	with	them?Assessing	the	size	and	identifying	the	sources	of	gains	from	trade	is	a	long-standing	challenge	for	economists.Theoretical	and	quantitative	studies	have	mostly	focused	on	static	economies	where	changes	in	international	marketintegration	have	only	one-time	effects	on	the	levels	of	income	and	consumption	but	do	not	affect	the	long-rundynamics	of	these	key	economic	variables.Since	innovation	and	technological	change	are	key	drivers	of	income	growth	in	the	long	run,	in	a	recent	research	wehave	explored	the	sources	and	assessed	the	size	of	the	gains	from	trade	in	a	model	economy	where	growth	spursfrom	technological	progress.	Our	findings	suggest	that	accounting	for	firms’	innovation	responses	doubles	the	gainsfrom	trade	obtained	in	static	quantitative	models.In	a	version	of	the	model	calibrated	to	the	US	economy	we	show	that	moving	from	autarky	to	the	current	US	tradelevel	yields	a	50	per	cent	permanent	increase	in	consumption,	half	of	which	is	due	to	innovation-driven	productivitygrowth.	This	result	suggests	that	dynamic	gains	are	of	first	order	importance	in	evaluating	the	impact	of	policiesaimed	at	liberalizing	or	curtailing	international	trade.Building	a	quantitative	model	for	policy	analysis	requires	a	theory	sufficiently	grounded	on	a	(large	enough)	set	ofrelevant	empirical	facts.	We	focus	on	the	following	facts,	each	corresponding	to	a	particular	channel	of	gains	fromtrade:Ffirst,	there	is	large	empirical	evidence	documenting	the	competition	effects	of	trade.	Increasing	foreign	competitionis	often	found	to	reduce	firm	prices	thereby	shrinking	their	profit	margins.	Lower	prices	benefit	consumer	byincreasing	their	purchasing	power—this	is	the	so-called	pro-competitive	effect	of	trade.LSE Business Review: We may be underestimating the gains from globalisation Page 1 of 3		Date originally posted: 2018-03-09Permalink: http://blogs.lse.ac.uk/businessreview/2018/03/09/we-may-b-underestimating-the-gains-from-globalisation/Blog homepage: http://blogs.lse.ac.uk/businessreview/Second,	the	reduction	in	profits	forces	some	of	the	less	profitable	and	less	productive	firms	out	of	the	market,	therebyreallocating	market	shares	toward	the	most	productive	firms.	This	selection	effect	generates	an	additional	channel	ofgains	from	trade,	as	more	productive	firms	charge	lower	prices.	Finally,	foreign	competitive	pressure	induces	firms	toinvest	in	innovation	to	improve	their	productivity.	This	innovation	effect	leads	to	dynamic	gains	from	trade,	as	higherproductivity	growth	produces	not	to	just	one-off	price	reductions	but	a	sequence	of	reductions	across	time,increasingly	benefiting	present	and	future	consumers.We	construct	a	model	embedding	all	three	key	channels	through	which	trade	can	potentially	increase	averageincome	and	consumption.	Frontier	quantitative	trade	models	consider	the	first	two	channels	in	static	economieswhere	the	effects	of	a	policy	change	take	place	at	once	through	reallocations	of	market	shares	across	firms	andsectors	but	each	firm’s	productivity	is	not	affected.	The	selection	and	competition	effects	of	trade	reallocateresources	toward	the	most	productive	firms,	thereby	increasing	the	average	level	of	productivity	and	reducing	prices.In	our	dynamic	economy,	trade-induced	reallocations	increase	the	size	of	the	most	productive	firms	and	raise	theirincentives	to	innovate,	pushing	up	the	growth	rate	of	productivity.	Hence,	the	model	is	able	to	separately	measurethe	static	gains	form	trade-induced	reallocations	of	market	shares	and	the	dynamic	gains	produced	by	the	interactionof	these	reallocation	and	innovation-driven	productivity	growth.In	our	main	quantitative	experiment,	we	explore	a	hypothetical	scenario	in	which	the	US	economy	completely	shutsdown	trade	with	foreign	countries.	This	counterfactual	scenario	brings	the	economy	from	its	current	import	level,	8.6per	cent	import-GDP	ratio,	to	autarky.	We	find	that	this	protectionist	shift	allows	American	firms	to	charge	highermarkups	on	the	domestic	market,	leading	to	a	30	per	cent	increase	in	the	average	profit	rate	(markup).The	reduction	in	foreign	competitive	pressure	makes	survival	easier	for	less	productive	US	firms	in	their	own	market,thereby	reducing	the	average	level	of	productivity.	Weaker	competition	and	selection	reduce	firms’	incentives	toinnovate	leading	to	lower	long-run	growth:	the	aggregate	growth	rate	of	the	economy	drops	from	1.25	to	0.8	per	cent.Due	to	the	combination	of	these	forces	the	average	long-run	consumption	per-capita	drops	by	50	per	cent,	adramatic	loss.	About	half	of	this	consumption	loss	is	accounted	for	by	the	effect	of	protectionism	on	firms’	incentivesto	innovate,	the	key	source	of	growth	in	modern	economies.	A	trade	liberalization	scenario	yields	similar	results	butwith	gains	in	the	place	of	losses.The	key	message	of	this	research	is	that	policy	evaluation	with	static	trade	models	is	likely	to	largely	underestimatethe	gains	or	losses	from	globalisation.	This	result	is	relevant	for	the	current	debate	on	the	economic	effects	Brexit.One	of	the	key	assessments	of	the	trade	consequences	of	Brexit	found	that	the	worse	case	scenario	of	no	deal	withthe	EU	would	imply	an	increase	in	trade	barriers	generating	a	loss	equal	to	2.7	per	cent	of	GDP	per	year,corresponding	to	£1,700	per	family	per	year.	This	hypothetical	scenario	of	no	deal	and	reversal	to	trading	under	WTOrules	is	evaluated	using	a	static	model.	We	speculate	that	this	is	a	conservative	estimate,	as	considering	dynamiceffects	would	likely	increase	the	size	of	the	loss	substantially.	Once	adapted	to	the	specific	exercise,	our	model	couldprovide	a	framework	for	a	more	comprehensive	assessment	of	the	long-run	impact	of	Brexit	and	other	large-scaletrade	reforms.♣♣♣Notes:This	blog	post	is	based	on	the	authors’	paper	Trade,	Firm	Selection	and	Innovation:	The	Competition	Channel,The	Economic	Journal,	2018.The	post	gives	the	views	of	its	author,	not	the	position	of	LSE	Business	Review	or	the	London	School	ofEconomics.Featured	image	credit:	London	City,	by	NadinLisa,	under	a	CC0	licenceWhen	you	leave	a	comment,	you’re	agreeing	to	our	Comment	PolicyLSE Business Review: We may be underestimating the gains from globalisation Page 2 of 3		Date originally posted: 2018-03-09Permalink: http://blogs.lse.ac.uk/businessreview/2018/03/09/we-may-b-underestimating-the-gains-from-globalisation/Blog homepage: http://blogs.lse.ac.uk/businessreview/Giammario	Impullitti	is	an	Associate	Professor	in	the	School	of	Economics	at	the	University	ofNottingham	since	September	2013.	Before	joining	Nottingham	he	was	an	assistant	professor	atCambridge	University	and	IMT	Lucca,	and	a	Max	Weber	post-doctoral	fellow	at	the	EuropeanUniversity	Institute	in	Florence.	He	is	am	a	research	Fellow	of	CESifo	Munich	and	Centro	D’AglianoMilano.	Omar	Licandro	joined	the	School	of	Economics,	University	of	Nottingham,	as	Professor	ofMacroeconomics	in	October	2015.	Previously	he	was	a	Research	Professor	at	the	Instituto	de	AnálisisEconómico	(CSIC),	which	he	first	joined	in	2009.	Since	2013,	he	has	been	Secretary	General	of	theInternational	Economic	Association	(IEA)	and	the	Executive	Secretary	of	the	Research	Institute	forDevelopment,	Growth	and	Economics	(RIDGE).	He	is	a	Associate	Professor	of	the	Barcelona	GSE,Fellow	of	CEPR	and	CESIfo.	He	was	Associate	Professor	at	Universidad	Carlos	III	de	Madrid,	1991-2000,	Senior	Researcher	at	FEDEA,	1994-2001	and	Professor	at	the	European	University	Institute,2001-2009.	He	has	been	Associate	Editor	of	Annales	d’Economie	et	de	Statistique,	Investigaciones	Economicas	andthe	Spanish	Economic	Review.	LSE Business Review: We may be underestimating the gains from globalisation Page 3 of 3		Date originally posted: 2018-03-09Permalink: http://blogs.lse.ac.uk/businessreview/2018/03/09/we-may-b-underestimating-the-gains-from-globalisation/Blog homepage: http://blogs.lse.ac.uk/businessreview/

We may be underestimating the gains from globalisation

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We may be underestimating the gains from globalisation

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