Unequal Gains, Prolonged Pain Protectionism and Democracy in the Brexit-Trump Era Emily J. Blanchard Gerald Willmann Tuck @ Dartmouth & CEPR U. Bielefeld & IFW Kiel Tel Aviv, May 2018
Brexit, Trump, Le Pen, AfD... Wouldn’t it be great if we had a model of populist backlashes?
Motivation Adjustment Costs Matter... Especially in Politics Structural change is slow and costly – abundant evidence that workers face large and long-lasting adjustment costs: e.g. Artuc, Chaudhuri, McLaren (AER ‘10); Autor, Dorn, Hanson (AER ‘13+); Dix-Caniero (Econometrica ‘14), etc. Political change is potentially much faster. Unanticipated shocks + sticky economic adjustment → even potential “winners” from change can be losers in the short run → political pushback
Economic Stickiness Shapes Political Outcomes A crucial distinction: Winners and losers in the long run: • Well understood (e.g. Mayer 1984): long run political outcome depends on distribution of gains. • Even in the long run equilibrium, policy and economic decisions are endogenous and interdependent. Winners and losers in the short run: • Dynamics are key; we need to take time seriously. ⇒ Most political economy models are static, steady state, or rigged to ensure “smooth” transition, and so miss key features of dynamic adjustment – the politics of time.
Overview of Approach This paper: 1 Develops a dynamic political economy model where policy can adjust quickly, but economic adjustment takes time. 2 Characterizes a salient political environment: • Labor market adjustment to macroeconomic shocks; • Endogenous policy tool is a tariff – highlights tradeoff between aggregate efficiency and redistribution. 3 Demonstrates the potential for Protectionist Overshooting and Protectionist Escalation in response to shocks. 4 Leverages model to consider ameliorating potential (or not) of redistribution, education policy, voting rules. 5 Examines key data markers suggested by the model.
Preview of Results Implications of the Theory 1 Unequal Gains ⇒ Prolonged Pain. • Important data marker: differential changes in the return to skills. Proxy with median vs. mean income changes 2 Efficiency costs of limited instruments in democracy are static and dynamic . 2017 Upshot: safeguards are crucial. 3 Long run outcome hinges on rising or falling inequality in individual-level returns to openness, ergo skills. 4 Along the way: • SBTC is essentially isomorphic → protectionist surges • ‘Complex redistribution’ → preferences over prices are key • Endogenous voter turnout: Skewness → engagement? 5 U.S./U.K. data suggestively different – reassuring?
Remainder of Talk Related Literature Model • Case 1: Protectionist Overshooting • Case 2: Protectionist Escalation Bonus implications: SBTC, redistribution, turnout Empirical implications & informative data markers Conclusion
Related Literature Trade and Labor Adjustment Matsuyama (1992); Davidson and Matusz (2008); Artuc, Chaudhuri, McLaren (2010); Davis and Harrigan (2011); Autor, Dorn, Hanson (et al) (2013 +); Dix-Caniero (2014); Krishna, Poole, Senses (2014), etc Endogenous Tariffs & Dynamic Trade Policy Mayer (1984); Staiger and Tabellini (1987); Fernandez and Rodrik (1991); Brainard and Verdier (1997); Dutt and Mitra (2002); Mayda and Rodrik (2005); Blanchard and Willmann (2011); many others Economic-Political Feedback; Democracy, Inequality, and SBTC e.g. Acemo˘ glu and Robinson (2013); Hassler, Rodr´ ıguez-Mora, Storesletten, & Zilibotti (2003); Acemo˘ glu, Gancia, and Zilibotti (2012); Acemo˘ glu, Naidu, Restrepo, Robinson (2013); Alesinia and Rodrik (1994); Persson and Tabellini (1994), etc.
Modeling Populist Surges: Brexit/Trump Dynamics? Heterogeneous OLG workers make lifelong (“putty-clay”) decisions over their own education, vote on policy. If expectations are correct, individual human capital investments, voting are ex-post optimal ⇒ steady state. Add an unanticipated global shock: e.g. a “China Shock” (TOT) – or SBTC – that exacerbates existing inequality. Skills are stuck, at least for a while, but policy can change. If politically pivotal voter is less skilled than ‘average’ ⇒ Popular Protectionist Surge
Sketch of the Model Individuals and Education Continuum of heterogenous agents live for 2 periods Agents born with innate ability, a ∈ [0 , 1] When young, choose optimal educational investment, e . Cost of education is foregone wages as a young, unskilled worker. Time constraint: l + e = 1 In second stage of life, education and ability → human capital, h ≡ h ( a, e ) s.t.: h a > 0 h e > 0 h ee < 0 h ae > 0
Sketch of Model, cont. Production and Trade Small open economy, Home Two goods: U , the numeraire and S , a skill-based good • U : one-for-one in unskilled labor → unskilled wage =1 • S : x ( h ) ≡ bh where b > 0 ( ↑ b ≈ SBTC) Return to acquiring h : bhp , where p ≡ p S p U is rel. price of S Home has comparative advantage in S . ⇒ Liberalization increases relative price of skill-based good; protectionism decreases it
Educational Investment Optimal educational attainment maximizes lifetime indirect utility. For the young voter at time t : V ( p t , I y t ( e ; p t )) + βV ( p t +1 , I o max t +1 ( h ( a, e ); p t +1 ) e where V ( p, I ) ≡ v ( p ) I . ⇒ Optimal education level, e ( a ; p t , p t +1 ) is • increasing in ability level (single crossing) • increasing in current & future price of S ◮ decreasing in current and future tariff, all else equal
Politics Median Voter Model (easily relaxed!) Majority voting. Median voter is decisive. Only the old vote. Individual tariff preference depends on a and education Individually optimal tariff given by the FOC: � � tpdE s ∂p t t ( a ) − ¯ [ E s E s t V τ ( a ) = v I t ] + = 0 . (1) ∂τ t dτ t � �� � ���� � �� � ≡ ∆ t ( a ) ( − ) = 0 @ t=0 � �� � � �� � std optimal tariff individual bias Lower (higher) ability/education ⇔ ∆( a ) < 0 (∆( a ) > 0)
Politics Equilibrium Trade Policy, τ t = τ ( a M ; e M t − 1 , ¯ e t − 1 ) Determined by education of median voter born in previous generation; Decreasing in median voter education level (holding remaining old generation’s education fixed); Depends critically on ∆ t ≡ ∆( e M t − 1 , ¯ e t − 1 ); i.e. the median relative to the average net skill position among the old generation. Individually Optimal Tariff Derivation
Solving the Model Solution Strategy 1 Define political equilibrium using median voter rule and rational expectations. 2 Steady state defined by τ ( e M ; ¯ e ), e M ( τ ). 3 Adopt ‘nice’ case conditions: unique, interior steady state 4 Shock the economy with a TOT improvement [or SBTC]; study dynamics
Political Equilibrium Definition A rational expectations political equilibrium is defined by a sequence of tariff and education rule pairs, ( τ t , e t ( a )) t ∈ N such that the following hold for all t ∈ N : 1 τ t maximizes indirect utility of the median voter given the previous period’s education schedule, e t − 1 ( a ); 2 e t ( a ) ≡ e ( a ; τ t , τ t +1 ) is optimal for every agent given rational expectations of current and future tariff levels.
Political Steady State Definition Political Steady State. A political steady state is reached when τ t ≡ T ( e M t − 1 ) = τ t − 1 ∀ t . A political steady state can be summarized by the steady state education level of the median e M , ˜ voter and concomitant policy outcome pair, { ˜ τ } : � � ˜ τ e M e M (˜ τ ) = h − 1 a M , ˜ = e βbp w e M ; ˜ V o ( τ ; a M , ˜ e M , ˜ τ ˜ = T (˜ e ) = arg max ¯ ¯ e ) . τ
Unique Stable Steady State
Permanent Terms of Trade Shock Our thought experiment Consider a permanent TOT improvement ( p w ↑ ) [or b ↑ ]. For any given tariff level, the incentive to acquire education would rise, but in the short run, the median voter will become more protectionist iff her net export position is below ‘average’. Characterize transition dynamics and new steady state
Preview of Results Permanent Protectionism or Temporary Setback? Two possibilities over the longer run: Protectionist Overshooting : Protectionist surge followed by gradual liberalization • Voters gradually increase skills, and close the gap: support for openness in response to increasing skill premium ⋆ Overshooting occurs even if new steady state trade policy is more liberal; a rosy long-run is preceded by rocky transition. Protectionist Escalation : Protectionist surge followed by further rise in tariffs • Even if voters upgrade skills, gap between majority and elite widens. Rising skewness → protectionism ↑ . ⋆ Rising education not necessarily enough to avoid backlash.
Steady state response to ↑ p w
Steady state response to ↑ p w e ( τ ) shifts right/up
Steady state response to ↑ p w τ ( e M ) shifts up iff median voter relatively less skilled ( ˜ ∆( a M ) < 0)
Steady state response to ↑ p w Net effect ambiguous – here, we depict case in which ˜ e ↑ and ˜ τ ↓
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