It is quite obvious that the gains from trade are positive, but implementing a free trade agreement obviously also implies some losses, in particular for workers whose skills were locked into the industry that just opened up. The implementation of some free trade agreements includes some compensation for such workers, but it is not much used if available. Why? And why would we need such compensation schemes at all?
Indeed, Marco de Pinto points out that unemployment insurance fulfills this role remarkably well. Those who benefit the most from the free trade agreement, and work, contribute to it, while those who lost, and are unemployed, receive insurance benefits. And if the unemployment insurance is not actuarially fair, that is OK, as it corresponds to a side-payment to the losers (no pun intended). But of course, the necessary taxation is distorting to the point of destroying the gains from trade. In such a context, it appears to be better to finance the unemployment insurance with a wage tax, as it neutral on all markets, in particular because under unionized labor markets, after tax wages are unchanged in aggregate. A profit tax is worse, but better than a payroll tax because it does not reduce labor demand for low-skilled workers as much.
Showing posts with label international markets. Show all posts
Showing posts with label international markets. Show all posts
How integrated are Eastern and Western Europe now?
25 years ago, it was very rare to see a car with Eastern European plates in Western Europe. Now, they are all over the place, including trucks (why are there so many from Romania?). This is a clear indication, even if you ignore history, that the East-West integration is stronger than it has been for a long time. But there are more aspects to integration than the movement of cars.
Catherine and Klaus Prettner basically look whether the two regions are cointegrated. They build two national aggregates, one with 12 European Community countries (unfortunately no UK) and 5 Central European countries. Using a vector error-correction model with restrictions from a standard open-economy business-cycle model with cash-in-advance. Output shocks to one area spill over to the other, surprisingly in similar magnitudes in both directions. Interest rate shocks are expectedly asymmetric though: West impacts East, but East does not impact West. But given that all this has been in transition mode over the 1995-2009 sample, I really wonder how these impacts have changed over time. A framework with time varying coefficients would have been helpful here.
Catherine and Klaus Prettner basically look whether the two regions are cointegrated. They build two national aggregates, one with 12 European Community countries (unfortunately no UK) and 5 Central European countries. Using a vector error-correction model with restrictions from a standard open-economy business-cycle model with cash-in-advance. Output shocks to one area spill over to the other, surprisingly in similar magnitudes in both directions. Interest rate shocks are expectedly asymmetric though: West impacts East, but East does not impact West. But given that all this has been in transition mode over the 1995-2009 sample, I really wonder how these impacts have changed over time. A framework with time varying coefficients would have been helpful here.
Are the Chinese capital controls optimal?
China is currently amassing large foreign reserves while imposing internally capital controls. Does this make sense? Wouldn't an economy that has the ability to create such surpluses want to participate more fully in world markets? One should not forget that these foreign reserves are accumulated thanks to a positive trade balance and a fixed exchange rate, not thanks to a particularly well functioning capital market in China. In fact, the financial sector in quite under-developed in China, and most households have access to nothing more than simple bank accounts.
Philippe Bacchetta, Kenza Benhima and Yannick Kalantzis build a model where the central bank has access to world market, but domestic households not. This enables the central bank to impose a different interest rate than the world interest rate, but it steady-state it is best to replicate an open economy: accumulate reserves and issue domestic debt at the world interest rate. If the economy grows rapidly, though, you want to have a higher interest rate domestically while imposing capital controls, that is, one needs to prevent arbitrage. But then, intertemporal substitution needs to happen through international reserves, as households cannot do it.
What is intriguing here is that we have a situation where open markets are welfare inferior to restricted ones with a reserve accumulation policy. Usually, we think that free markets would work best, especially as here there is no moral hazard, systemic risk, or other distortion. The reason is that borrowing constraints are binding as the economy converges towards steady state, and it cannot provide adequate intertemporal allocation in open markets. The central bank needs to help, and needs to differentiate interest rates to do so. That can only happen with capital controls.
Philippe Bacchetta, Kenza Benhima and Yannick Kalantzis build a model where the central bank has access to world market, but domestic households not. This enables the central bank to impose a different interest rate than the world interest rate, but it steady-state it is best to replicate an open economy: accumulate reserves and issue domestic debt at the world interest rate. If the economy grows rapidly, though, you want to have a higher interest rate domestically while imposing capital controls, that is, one needs to prevent arbitrage. But then, intertemporal substitution needs to happen through international reserves, as households cannot do it.
What is intriguing here is that we have a situation where open markets are welfare inferior to restricted ones with a reserve accumulation policy. Usually, we think that free markets would work best, especially as here there is no moral hazard, systemic risk, or other distortion. The reason is that borrowing constraints are binding as the economy converges towards steady state, and it cannot provide adequate intertemporal allocation in open markets. The central bank needs to help, and needs to differentiate interest rates to do so. That can only happen with capital controls.
An economist's foray into econophysics
I have described here some of the outlandish forays of physicists into Economics, where they try to use concepts from their discipline with disastrous results (last post here). But economists themselves may borrow concepts from physics. One that stuck was sunspots, from some chance correlation between sunspot activity and stock market performance, and made popular by David Cass and Karl Shell. But there were very little physics in this.
Martin Evans ventures deeper, using the concept of dark matter to understand exchange rate movements. It is well known that it is very difficult to understand what moves exchange rates. Dark matter is something that we cannot observe, but we see its impact. In this case, Evans builds a model where dark matter has an impact on nominal exchange rates, and then on other variables. This is based on the empirical observation that something like dark matter has an impact on expectations on long-run exchange rates, but not on recent and future interest rate differentials. This is achieved in the model by introducing shocks to household risk aversion. Why? Well, it is dark matter (or animal spirits). But all that matters is that it explains a large share of exchange rate fluctuations, in a rather consistent way for the other variables. Physicists would be happy with that. Economists would want to understand why.
Martin Evans ventures deeper, using the concept of dark matter to understand exchange rate movements. It is well known that it is very difficult to understand what moves exchange rates. Dark matter is something that we cannot observe, but we see its impact. In this case, Evans builds a model where dark matter has an impact on nominal exchange rates, and then on other variables. This is based on the empirical observation that something like dark matter has an impact on expectations on long-run exchange rates, but not on recent and future interest rate differentials. This is achieved in the model by introducing shocks to household risk aversion. Why? Well, it is dark matter (or animal spirits). But all that matters is that it explains a large share of exchange rate fluctuations, in a rather consistent way for the other variables. Physicists would be happy with that. Economists would want to understand why.
Increasing public debt is a consequence of financial liberalization and inequality
The current debt crisis is the culmination of a long process of public debt accumulation over the last three decades in developed economies. Why this trend? I do not think it has suddenly become fashionable for governments to go deeper in debt, or that suddenly we came up with policy prescription leading that way more than before.
Marina Azzimonti, Eva de Francisco and Vincenzo Quadrini think it has to do with financial liberalization and globalization. The fact that more financial instruments and opportunities are now available certainly must contribute. There is already considerable evidence that the emergence of new borrowing instruments has increased household borrowing in the US, in particular for unsecured debt (credit cards). What these authors show is that a key component in the endogenous increase in public debt is a concurrent increase in income inequality in a political equilibrium. Public debt is beneficial because allows intertemporal smoothing. But at some point, higher debt leads to interest rates too high for the good of a majority. Interestingly, the model shows that it is not necessary for inequality to increase in all countries for this to happen. Globalization leads to a world-wide market, and local interest rates are largely determined on that market.
Marina Azzimonti, Eva de Francisco and Vincenzo Quadrini think it has to do with financial liberalization and globalization. The fact that more financial instruments and opportunities are now available certainly must contribute. There is already considerable evidence that the emergence of new borrowing instruments has increased household borrowing in the US, in particular for unsecured debt (credit cards). What these authors show is that a key component in the endogenous increase in public debt is a concurrent increase in income inequality in a political equilibrium. Public debt is beneficial because allows intertemporal smoothing. But at some point, higher debt leads to interest rates too high for the good of a majority. Interestingly, the model shows that it is not necessary for inequality to increase in all countries for this to happen. Globalization leads to a world-wide market, and local interest rates are largely determined on that market.
Currency unions and trade
One of the supposed benefits of monetary union is that it leads to an increase in trade. The basic mechanism is that the exchange risk disappears and thus also the (implicit) insurance cost of that risk. How large the impact of this particular trading cost is, or its disappearance, is not well established in the empirical trade literature.
Douglas Campbell tacks a new tack at this question using a dynamic gravity model. He uses historical instances of countries breaking away from a currency union, thus the question is somewhat different from what I indicated in the leading paragraph, especially as the dynamics may be quite different. Also, the circumstances leading to a breaking up (think of the current possibility of Greece leaving the Euro) can lead by themselves to fluctuations in trade, especially in the short term. It appears, the earlier literature largely ignored these circumstances. Taking them into account reduces the impact to a measly 1% of trade volume, although quite imprecisely estimated. The consequences of Greece leaving the Euro may thus not be of much significance, especially on the trade front.
Douglas Campbell tacks a new tack at this question using a dynamic gravity model. He uses historical instances of countries breaking away from a currency union, thus the question is somewhat different from what I indicated in the leading paragraph, especially as the dynamics may be quite different. Also, the circumstances leading to a breaking up (think of the current possibility of Greece leaving the Euro) can lead by themselves to fluctuations in trade, especially in the short term. It appears, the earlier literature largely ignored these circumstances. Taking them into account reduces the impact to a measly 1% of trade volume, although quite imprecisely estimated. The consequences of Greece leaving the Euro may thus not be of much significance, especially on the trade front.
Being landlocked and making it worse
No matter how you specify your growth regression, it always turns out that being landlocked is bad for a country. The lack of direct access to the sea and thus world markets seems to hurt the capacity to specialize for exports and acquire cheap imports. As a consequence, it stands to reason that any landlocked country should try to circumvent this physical hurdle by creating institutions that foster trade, say by joining free-trade agreements.
Well, the reality seems to be the exact opposite. Ingo Borchert, Batshur Gootiiz, Arti Grover and Aaditya Mattoo find that landlocked economies in general have more restrictive policies in anything that relates to trade and interacting with the rest of the world, such as telecommunications and transportation. And with such policies, international policy assistance is unlikely to have much impact. But one make also ask oneself whether landlocked countries naturally tend to shun the rest to the world, an attitude that is difficult to overcome.
Well, the reality seems to be the exact opposite. Ingo Borchert, Batshur Gootiiz, Arti Grover and Aaditya Mattoo find that landlocked economies in general have more restrictive policies in anything that relates to trade and interacting with the rest of the world, such as telecommunications and transportation. And with such policies, international policy assistance is unlikely to have much impact. But one make also ask oneself whether landlocked countries naturally tend to shun the rest to the world, an attitude that is difficult to overcome.
Exchange rate modelling: is the random walk beatable?
Forecasting price movements on asset markets is very difficult, especially at high frequencies. This is also true for exchange rates, where economists have been hard-pressed to come up with a theoretical or statistical model that can beat a random walk. And when they did, it did not hold up to the test of time. So what is the latest in this quest?
Mario Cerrato, John Crosby and Muhammad Kaleem point out the the statistical tests used to evaluate the forecasting performance and not relevant. Indeed, one does not care whether the mean square errors are low out of sample, or what the Sharpe ratio is. What really matters is how a portfolio managed using the forecasting model performs. And there, the news is good, one can beat the random walk. And this not even with a purely statistical model, but rather with a model that has some theoretical foundations. Very few of those are needed: money and GDP growth in both countries, and a time trend, the latter not being essential to beat the random walk. One can imagine that a more elaborate model could do even better.
But note that nobody here has claimed you can beat the market.
Mario Cerrato, John Crosby and Muhammad Kaleem point out the the statistical tests used to evaluate the forecasting performance and not relevant. Indeed, one does not care whether the mean square errors are low out of sample, or what the Sharpe ratio is. What really matters is how a portfolio managed using the forecasting model performs. And there, the news is good, one can beat the random walk. And this not even with a purely statistical model, but rather with a model that has some theoretical foundations. Very few of those are needed: money and GDP growth in both countries, and a time trend, the latter not being essential to beat the random walk. One can imagine that a more elaborate model could do even better.
But note that nobody here has claimed you can beat the market.
The surprisingly low border effect of the BigMac
The Economist's BigMac Index is widely used as an indicator of purchasing power parity. I have never been convinced that it is an appropriate indicator, though. But studies keep using it, and teachers keep mentioning it.
The latest is Anthony Landry who uses it to study the border effect, i.e., how a border adds to the cost of transportation. That assumes that BicMacs are all produced in one location and then shipped to all stores worldwide. This clearly is not the case, both for the raw material and for the assembly. While the raw material is produced centrally in each country, it is only rarely passing a border due to regulation and preferences for local product. I thus do not see the point of estimating borders effects with BigMacs.
The latest is Anthony Landry who uses it to study the border effect, i.e., how a border adds to the cost of transportation. That assumes that BicMacs are all produced in one location and then shipped to all stores worldwide. This clearly is not the case, both for the raw material and for the assembly. While the raw material is produced centrally in each country, it is only rarely passing a border due to regulation and preferences for local product. I thus do not see the point of estimating borders effects with BigMacs.
The recent collapse in the trade of durable goods
One important feature of the recent crisis has been a significant drop in international trade. There is nothing surprising in this, as it is a regular feature of recessions that imports decrease more than GDP, as they are mostly composed of intermediate and investment goods. And it is well known that investment is very volatile through the business cycle. This are all well-known facts, that are easy to replicate with standard international business cycle models.
Dimitra Petropoulou and Kwok Tong Soo look at this trade drop from the perspective of trade theorists. They use a small open economy model (hence prices are exogenous) with two-period overlapping generations (hence we are talking about long-term movements, not business cycles) with tradable durable goods and a non-tradable non-durable good. There is a fix endowment of labor and capital that can freely be allocated between sectors (hence there is no investment, or savings). Agents can freely borrow and lend within a generation, but not between generations or with abroad.
Why do I mention this? Because Petropoulou and Soo try to reinvent the wheel and make it square. There is a large international business cycle literature that has gone through all this with much more realistic assumption and delivered quantitative results. And this not the first time I see that trade theorists could learn a lot by reading a little bit outside their bubble.
Dimitra Petropoulou and Kwok Tong Soo look at this trade drop from the perspective of trade theorists. They use a small open economy model (hence prices are exogenous) with two-period overlapping generations (hence we are talking about long-term movements, not business cycles) with tradable durable goods and a non-tradable non-durable good. There is a fix endowment of labor and capital that can freely be allocated between sectors (hence there is no investment, or savings). Agents can freely borrow and lend within a generation, but not between generations or with abroad.
Why do I mention this? Because Petropoulou and Soo try to reinvent the wheel and make it square. There is a large international business cycle literature that has gone through all this with much more realistic assumption and delivered quantitative results. And this not the first time I see that trade theorists could learn a lot by reading a little bit outside their bubble.
Corruption and the exchange rate regime
A fixed exchange rate regime is a sign of an authoritarian and weaselly government nowadays. Letting your currency float lets markets freely show when policies are weak. Governments who are afraid of showing such weakness either get a fixed exchange rate regime or announce a floating one and in practice manage it to make it look stable as a fixed one. This is the so-called fear of floating, common among corrupt governments. This would indicate that the choice of the exchange rate regime could be determined by the political regime. Could the causality run the other way?
Katherina Popkova studies this question and finds the rather striking result that it makes sense to have an fixed exchange rate when you are corrupt and corruption has a strongly positive impact on output. The logic is that in such circumstances taxation is not that much distorting, thus seigniorage can be efficiently replaced by taxes. That said, some may argue that it is a silly idea to mention that corruption may have a positive impact on output. Yet, it is far from empirically settled whether corruption has a positive or negative impact.
Katherina Popkova studies this question and finds the rather striking result that it makes sense to have an fixed exchange rate when you are corrupt and corruption has a strongly positive impact on output. The logic is that in such circumstances taxation is not that much distorting, thus seigniorage can be efficiently replaced by taxes. That said, some may argue that it is a silly idea to mention that corruption may have a positive impact on output. Yet, it is far from empirically settled whether corruption has a positive or negative impact.
Monetary and fiscal policy cooperation in a liquidity trap
We are living interesting times in terms of macroeconomic policy: the world faces big shocks and substantial challenges, and many current circumstances have no historical precedents. This means that policy makers cannot draw from experience and need to invent new policies from somewhere better than their guts. And after a few hesitations, theory is now in much better shape to answer questions from policy makers. For example, what should one do when there is a liquidity trap in a globalized economy, especially if the trap itself is globalized?
David Cook and Michael Devereux show how, and it borders on a political miracle. Not only does one need to get the cooperation of fiscal and monetary authorities (something the US is not close to achieving) but one needs the cooperation across countries even if it entails some costs to the "winners" (something the Chinese have so far refused and the Swiss recently abandoned).
Specifically, Cook and Devereux show that with so many countries currently with negative real interest rates, we have a worldwide liquidity trap. In an open economy, the policy prescription differs from a closed economy. If there is a negative demand shock, fiscal policy needs of course to raise aggregate demand, but with a global economy, this can come from anywhere in the world and thus a coordinated fiscal policy is due. But to channel the impulse to the relevant countries, monetary policy coordination is necessary to raise interest rates in the foreign countries, even if they are in a liquidity trap. And this takes some serious courage. One can always dream.
David Cook and Michael Devereux show how, and it borders on a political miracle. Not only does one need to get the cooperation of fiscal and monetary authorities (something the US is not close to achieving) but one needs the cooperation across countries even if it entails some costs to the "winners" (something the Chinese have so far refused and the Swiss recently abandoned).
Specifically, Cook and Devereux show that with so many countries currently with negative real interest rates, we have a worldwide liquidity trap. In an open economy, the policy prescription differs from a closed economy. If there is a negative demand shock, fiscal policy needs of course to raise aggregate demand, but with a global economy, this can come from anywhere in the world and thus a coordinated fiscal policy is due. But to channel the impulse to the relevant countries, monetary policy coordination is necessary to raise interest rates in the foreign countries, even if they are in a liquidity trap. And this takes some serious courage. One can always dream.
What if the US looses its reserve currency privilege?
Since the Bretton Woods agreement in 1945, the United States have enjoyed the so-called "Exhorbitant Privilege." During the fixed exchange rate regime, the US could conduct monetary policy without regard to what was happening in other countries. The US dollar was a reserve currency, which also helped the US maintain low interest rates and a guarantee that US dollars (and Treasury bonds) would always find a buyer. With flexible exchange rates, not much has changed. But with the recent shenanigans in a Congress that considered reneging on its debt, the likelihood of this advantage changing has dramatically increased. What would the consequences of the loss of the Exhorbitant Privilege be?
Wenli Cheng and Dingsheng Zhang study this scenario using a general equilibrium model where a peripheral country (say, the Asian economies) pegs its currency to the money of a central country (say, the United States), the latter being used as the vehicle currency for international trade. In addition, the foreign exchange reserves of the periphery are invested in government bonds of the center. This means that no matter what current account deficit of the center, it is always financed by the periphery. Yet the center may be tempted to inflate it away. This limitless and to some extend free borrowing is the Exhorbitant Privilege.
Now remove it by assuming that the periphery does not want to invest in the center, either because it views the Treasury bonds are excessively risky or because it does not peg to the dollar any more. This would lead to a dramatic readjustment of the terms of trade to favor the tradable sector of the center. This decpraciation of the dollar would be more pronounced of the center is incapable of raising taxes and finances its debt with inflation. This already all sounds familiar.
Wenli Cheng and Dingsheng Zhang study this scenario using a general equilibrium model where a peripheral country (say, the Asian economies) pegs its currency to the money of a central country (say, the United States), the latter being used as the vehicle currency for international trade. In addition, the foreign exchange reserves of the periphery are invested in government bonds of the center. This means that no matter what current account deficit of the center, it is always financed by the periphery. Yet the center may be tempted to inflate it away. This limitless and to some extend free borrowing is the Exhorbitant Privilege.
Now remove it by assuming that the periphery does not want to invest in the center, either because it views the Treasury bonds are excessively risky or because it does not peg to the dollar any more. This would lead to a dramatic readjustment of the terms of trade to favor the tradable sector of the center. This decpraciation of the dollar would be more pronounced of the center is incapable of raising taxes and finances its debt with inflation. This already all sounds familiar.
Trade constraints of developing countries
With all the current posturing in the US and Europe, while addressing doubtlessly important problems, it is easy to forget that there are much bigger issues that need to be solved: how to get the poor and especially the poorest economies to a decent standard of living. We have been blessed to be born in the right families and in the right countries, and we should share this luck with those who were no so fortunate. This does not necessarily mean to give to the poor, just giving them a fair chance may be enough.
Jean-Jacques Hallaert, Ricardo Cavazos Cepeda and Gimin Kang consider the consequences of trade barriers on developing economies. The latter should be able to benefit greatly from selling on world markets goods produced with the factor they are relatively rich of, unskilled labor and to some extend land, while importing the complementary goods, likely capital-intensive investment goods. This OECD study finds that developed economies cannot do much more in terms of reducing import tariffs. Where there is more potential is with home-grown issues: unreliability of electricity, high transportation costs, poor education, bad governance, and instability. These results have been obtained by regressing exports, imports or their sum on a number of indicator for a panel of data. I am not particularly keen on these exercises due to poor data quality, gigantic endogeneity and especially the fact that proxies for essentially unquantifiable variables are used, like property rights and governance. But I suppose this is the best one can do, and the results appear to be rather stark. Now as to how to solve these economic problems, that is a gigantic task that we should be really talking about these days, instead of posturing for political gain.
Jean-Jacques Hallaert, Ricardo Cavazos Cepeda and Gimin Kang consider the consequences of trade barriers on developing economies. The latter should be able to benefit greatly from selling on world markets goods produced with the factor they are relatively rich of, unskilled labor and to some extend land, while importing the complementary goods, likely capital-intensive investment goods. This OECD study finds that developed economies cannot do much more in terms of reducing import tariffs. Where there is more potential is with home-grown issues: unreliability of electricity, high transportation costs, poor education, bad governance, and instability. These results have been obtained by regressing exports, imports or their sum on a number of indicator for a panel of data. I am not particularly keen on these exercises due to poor data quality, gigantic endogeneity and especially the fact that proxies for essentially unquantifiable variables are used, like property rights and governance. But I suppose this is the best one can do, and the results appear to be rather stark. Now as to how to solve these economic problems, that is a gigantic task that we should be really talking about these days, instead of posturing for political gain.
Shortsightedness and tariffs
International trade theory is in large part about optimal trade theory, yet it is incapable to explain the observed level of tariffs. While under rather general circumstances theory will tell you that zero tariffs will improve general welfare, once you take into account that governments threaten and negotiate in a Nash equilibrium, tariffs should be at about 30%. They are generally far below that. It is a big challenge to explain the difference.
Mario Larch and Wolfgang Lechthaler argue that all that is needed is for trade theory to finally catch up with the rest of economics and use some dynamics. Specifically, transform the problem into a dynamic Nash equilibrium, take into account transition paths, and you get some realistic numbers if you assume that the negotiating politicians are short-sighted, which is certainly not far from the truth. This is important because the various transitional effect of a tariff change take different times. Indeed a decrease in tariffs has a faster and positive impact on consumption through an immediate increase in consumption. A counter-effect through the closing of inefficient firms takes much longer. Impatient politicians discount heavily the latter.
Mario Larch and Wolfgang Lechthaler argue that all that is needed is for trade theory to finally catch up with the rest of economics and use some dynamics. Specifically, transform the problem into a dynamic Nash equilibrium, take into account transition paths, and you get some realistic numbers if you assume that the negotiating politicians are short-sighted, which is certainly not far from the truth. This is important because the various transitional effect of a tariff change take different times. Indeed a decrease in tariffs has a faster and positive impact on consumption through an immediate increase in consumption. A counter-effect through the closing of inefficient firms takes much longer. Impatient politicians discount heavily the latter.
Cross-border banking and financial stability
Should banks be allowed to do business across borders? The answer is not obvious. For one, it is beneficial that they have the opportunity to better diversify their risks, but they can do this without having to open branches in other states or countries. The counterpart is that doing business elsewhere increases opportunities for adverse shocks. Finally, regulatory competition in an international banking market leads to a large systemic risk.
Dirk Schoenmark and Wolf Wagner try to sort this out in the case of Europe and come to the conclusion that it depends. They argue that Germany and the UK are well diversified and thus can sustain cross-border banking, even though there appears to be overexposure to the US, as exemplified by the large negative consequences in Europe of the recent crisis in the US. For the countries on the fringes of Europe, though, there seems to be very poor diversification. Indeed, these economies seem to be very dependent on a few large foreign banks, and consequences could be dire if they run into difficulties or decide to pull out.
This analysis is entirely based on asset shares and thus diversification. This neglects a major advantage of foreign banks: they bring lending capital that would otherwise not be available. The case for cross-border banking is thus understated in this paper.
Dirk Schoenmark and Wolf Wagner try to sort this out in the case of Europe and come to the conclusion that it depends. They argue that Germany and the UK are well diversified and thus can sustain cross-border banking, even though there appears to be overexposure to the US, as exemplified by the large negative consequences in Europe of the recent crisis in the US. For the countries on the fringes of Europe, though, there seems to be very poor diversification. Indeed, these economies seem to be very dependent on a few large foreign banks, and consequences could be dire if they run into difficulties or decide to pull out.
This analysis is entirely based on asset shares and thus diversification. This neglects a major advantage of foreign banks: they bring lending capital that would otherwise not be available. The case for cross-border banking is thus understated in this paper.
Should there be international trade in pollution rights?
A basic principle in Economics is that of comparative advantage: a country will produce the goods that it is relatively better at producing, even it is bad at it. The traditional story usually includes relative endowments in capital and labor, and the capital intensity of goods matters. Now add environmental externalities. Comparative advantage would say that polluting production should take place were pollution is the "cheapest," that is. where it would have fewer consequences. This is the principle being the introduction of an international market for pollution rights. Such markets are already active within countries, with the idea that firms that can best control pollution will produce the polluting goods, as they need fewer pollution rights. Would this basic principle also hold across countries?
Jota Ishikawa, the late Morihiro Yomogida and Kazuharu Kiyono claim that it is not necessarily beneficial to have an international market. Indeed they point out that rich countries could import pollution rights from the poor countries, thereby further deteriorating the environment in the developed economies. So instead of relocating production, pollution is imported. It all depends on comparative advantage.
Jota Ishikawa, the late Morihiro Yomogida and Kazuharu Kiyono claim that it is not necessarily beneficial to have an international market. Indeed they point out that rich countries could import pollution rights from the poor countries, thereby further deteriorating the environment in the developed economies. So instead of relocating production, pollution is imported. It all depends on comparative advantage.
Using the WTO to overcome a prisoner's dilemma
It looks like the threat of competitive increases in trade tariffs has vanished, at least for the moment, as economies are getting back in shape. This episode highlighted how tariffs are part of a prisoner's dilemma: increasing tariffs is good for you, at least in the short term, as it gives more market share to local firms and/or more revenue to the state. But it hurts the foreign country, and if everybody does it, joint welfare is reduced because of the lower gains from exchange, the misallocation of productive resources and the loss of competitiveness of protected industries. It is precisely because of this prisoner's dilemma that the GATT (General Agreement on Tariffs and Trade) and then the WTO (World Trade Organization) were put in place.
Renee Bowen takes this reasoning further by looking a at a multilateral prisoner's dilemma, and interestingly the optimal institution that emerges looks very much like WTO's dispute settlement mechanism, in that countries cannot retaliate while a dispute is being settled. The key is that once a large enough number of countries participate in the WTO, the threat of sanctions is sufficient to obtain settlement and nobody is compelled to jump the gun with retaliations.
Renee Bowen takes this reasoning further by looking a at a multilateral prisoner's dilemma, and interestingly the optimal institution that emerges looks very much like WTO's dispute settlement mechanism, in that countries cannot retaliate while a dispute is being settled. The key is that once a large enough number of countries participate in the WTO, the threat of sanctions is sufficient to obtain settlement and nobody is compelled to jump the gun with retaliations.
The Dalai Lama effect on international trade
Since the Nobel Peace Prize was announced this year, the Chinese government has been putting heavy pressure on many foreign authorities to prevent them from showing up at the award ceremony. China has been in particular been using the threat of trade sanctions to ruin the party of Liu Xiaobo. Is this effective?
Andreas Fuchs and Nils-Hendrik Klann note that China is a regular with these tactics, but regarding contacts with the Dalai Lama. Are those threats carried out? Using a gravity model, they find exports to China have been curtailed after high-level visits only recently, and this effect vanishes after two years. This is quite interesting, as it confirms the existence of a "Dalai-Lama effect." But I wonder how this effect could appear at a time where the Chinese government has less control over imports with the liberalization of the economy. Is it that it cares that much more about the Dalai Lama?
Andreas Fuchs and Nils-Hendrik Klann note that China is a regular with these tactics, but regarding contacts with the Dalai Lama. Are those threats carried out? Using a gravity model, they find exports to China have been curtailed after high-level visits only recently, and this effect vanishes after two years. This is quite interesting, as it confirms the existence of a "Dalai-Lama effect." But I wonder how this effect could appear at a time where the Chinese government has less control over imports with the liberalization of the economy. Is it that it cares that much more about the Dalai Lama?
Sovereign debt and the age pyramid
The papers about sovereign debt I come across always assume that the debt is held by some social planner who implicitly is acting on the behalf of representative and identical agents. But not all international debt is held by governments, and not everyone in a country has the same opinions regarding this debt.
Martín Gonzalez-Eiras deviates from this literature by including demographics, and in particular how there can be intergenerational conflict about the handling of debt. Obviously, reneging has different consequences whether you are young or old. He also looks at how outcomes can differ if the demographic structure of a country changes.
The paper highlights one interesting mechanism that should provide larger incentives to prevent default. Important transfers between generations are welfare improving, and they can further improved by having access to international insurance. This implies that these intergenerational transfers act as international collateral, and thus make it possible to obtain self-enforcing contracts. A country with a large retirement pension system provided by the state is this less likely to default and more likely to obtain gains in efficiency through participation in international insurance.
Martín Gonzalez-Eiras deviates from this literature by including demographics, and in particular how there can be intergenerational conflict about the handling of debt. Obviously, reneging has different consequences whether you are young or old. He also looks at how outcomes can differ if the demographic structure of a country changes.
The paper highlights one interesting mechanism that should provide larger incentives to prevent default. Important transfers between generations are welfare improving, and they can further improved by having access to international insurance. This implies that these intergenerational transfers act as international collateral, and thus make it possible to obtain self-enforcing contracts. A country with a large retirement pension system provided by the state is this less likely to default and more likely to obtain gains in efficiency through participation in international insurance.
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