Unequal Gains, Prolonged Pain Protectionism and Democracy in the - - PowerPoint PPT Presentation

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
• utcome 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)

• f 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.: ha > 0 he > 0 hee < 0 hae > 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 ≡ pS

pU 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: max

e

V (pt, Iy

t (e; pt)) + βV (pt+1, Io t+1(h(a, e); pt+1)

where V (p, I) ≡ v(p)I. ⇒ Optimal education level, e(a; pt, pt+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: Vτ(a) = vI

• [Es

t (a) − ¯

Es

t ]

• ≡∆t(a)

∂pt ∂τt

• (−)
• individual bias

+ tpdEs

t

dτt

= 0 @ t=0

• std optimal tariff

= 0. (1) Lower (higher) ability/education ⇔ ∆(a) < 0 (∆(a) > 0)

Politics

Equilibrium Trade Policy, τt = τ(aM; eM

t−1, ¯

et−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 ≡ ∆(eM

t−1, ¯

et−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(eM; ¯

e), eM(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, (τt, et(a))t∈N such that the following hold for all t ∈ N:

1 τt maximizes indirect utility of the median voter given the

previous period’s education schedule, et−1(a);

2 et(a) ≡ e(a; τt, τt+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 τt ≡ T(eM

t−1) = τt−1 ∀t. A political steady state can be

summarized by the steady state education level of the median voter and concomitant policy outcome pair, {˜ eM, ˜ τ}: ˜ eM = eM(˜ τ) = h−1

e

• aM,

˜ τ βbpw

• ˜

τ = T(˜ eM; ˜ ¯ e) = arg max

τ

V o(τ; aM, ˜ eM, ˜ ¯ e).

Unique Stable Steady State

Permanent Terms of Trade Shock

Our thought experiment Consider a permanent TOT improvement (pw ↑) [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 ↑ pw

Steady state response to ↑ pw

e(τ) shifts right/up

Steady state response to ↑ pw

τ(eM) shifts up iff median voter relatively less skilled ( ˜ ∆(aM) < 0)

Steady state response to ↑ pw

Net effect ambiguous – here, we depict case in which ˜ e ↑ and ˜ τ ↓

Time Path of Adjustment to pw ↑ at time T

⋆ Policy adjusts immediately – Education takes time Immediate jump in τ Tariff locus pivots/steepens: τ(eM; pw1) > τ(eM; pw0) Since eM

t−1 fixed, ⇒ τT > ˜

τ: tariff jumps at T iff ∆(aM) < 0 Thereafter, τt+1 = τ(eM

t ; pw1, ¯

et) = τ(∆t+1(aM); pw1). Median voter’s education stuck at T, then rises Education Rule et = e(aM; pt, pt+1) Can prove that tariff spike offers partial protection, i.e. pT > ˜ p, which implies eT+1(a) > ˜ e(a) ∀a. ⋄ Overshooting Case: If ∆t+1(aM) > ∆t(aM) → τt+1 < τt ∀t ≥ T: tariff gradually diminishes over time

Time Path of Adjustment: Overshooting Case [∆(aM) ↑ing]

Time Path of Trade Policy Adjustment

Time Path of Trade Policy Adjustment

Note: “Overshooting” can occur with new SS tariff above or below old SS

Time Path of Human Capital Adjustment

Gradual Skill Upgrading

Time Path of Price Adjustment

Policy as Shock Absorber

Dynamic Efficiency Costs (and the Value of Safeguards)

Alternative Case: Permanent Protection

What if mean-median gap increases? (∆(aM) ↓)

Alternative Case

Increasing Protectionism

Pit-stop Summary

Protectionist Overshooting or Rising Protectionism?

When human capital gains are skewed toward the top ( ˜ ∆(aM) < 0), ↑ pw causes protectionist surge: τT > ˜ τ Initial tariff spike will not fully offset the increase in pw, so education increases among the young generation: eT > ˜ e. In the long run, 2 possibilities:

• If median voter’s human capital (net export position) rises

faster than the average, ∆M ↑ ⇒ tariffs fall and education continues to rise. ˜ ˜ τ < τT .

• If median voter’s human capital (net export position) rises

slower than the average, ∆M ↓ ⇒ tariffs rise further and educational gains reverse. ˜ ˜ τ > τT .

Pit-stop Summary

Additional Implications of the Model

1 SBTC is essentially isomorphic to a terms of trade shock in

political consequences. ⇒ What starts with SBTC could end with a trade war.

2 “Simple Redistribution” will not dampen protectionist zeal. 3 First best ‘politically viable’ instruments are the least

distortionary means that align the preferences of the median (or political pivotal) voter over prices with the representative agent.

4 Pushing the model, these macro shocks can change voter

turnout via increased spread in ∆.

Recall the Optimal Tariff Expression

Vτ(a) = vI

• ∆t(a)∂pt

∂τt + tpdEs

t

dτt

• = 0.

(2) With CD preferences, SBTC effect immediate: Vτ(a) = vI

• (1 − α)b(h(a) − ¯

h)∂pt ∂τt + tpdEs

t

dτt

• = 0.

(3) Lower (higher) ability/education ⇔ ∆(a) < 0 (∆(a) > 0)

Individually Optimal Tariff Derivation

Empirical Implications

Conditions for Protectionist Surges and Overshooting

1 The shock makes the politically pivotal (e.g. median) voter

more protectionist in the short-run:

• Returns to openness/skill are skewed toward the top.

2 For Overshooting: Through education/skill acquisition,

skewness in returns to human capital will fall over time. i.e. the majority catches up.

3 For Permanent Protection: median continues to fall behind.

[? ] Are voters are politically enfranchised? (Is median voter rule a fair approximation?)

U.S. Mean and Median (Real) Income Since 1975

Source: US Census

Mean-Median Gaps (∆) Across Countries

Source: US Census; UK ONS; Eurostat

Stickiness Index (intergen. earnings ε): Corak (2006)

British and American Exceptionalism? (Let’s hope...)

Same story, different metric. (Corak and Kruger (2012))

Chetty’s “Declining American Dream” (Chetty et al. (2016))

• Pct. of children earning more than their parents

Child’s Birth Cohort

The All-important Question

Can the Majority Share in Globalization’s Gains (eventually)?

A Pessimistic View Artuc et al (2010); Autor et al (2013+); Dix-Caniero (2014) Winner-take-all/superstar returns to human capital Stolper-Samuleson + dist’n of capital [Piketty: r > g?] Conversely UBTC could ↓ skewness Educational institutions designed to enable ‘catching up’ If transfers/educational investment are democratically determined, inequality could be self-correcting...

Summary

Transitions are important, not obvious, and depend on differential stickiness.

• The more unequally a shock is felt, the greater and more

persistent the political response

Long-Run democratic response to shocks depends on the skewness in individual ‘net export position’

• Simply increasing (all) education may not be enough to get

globalization buy-in; need to reduce skewness in returns to

• penness.

In context of the model, U.S., U.K. seem to be outliers. Key question: how flexible are workers in the long run? Can the majority narrow the gap?

Methodological Contribution

Introduce ‘Policy Overshooting’ Tractable model of political adjustment process based on simple insight: policy may respond faster than structural change Broad range of applications: trapped factors, social security, alternative fuel adoption; etc.

Thank You!

Not simply a question of education

Median ¡Voter ¡

Source: US Census via Haskel, Lawrence, Slaughter JEP 2012

Conditions for Uniqueness and Stability

Assumption 2 Sufficient Conditions for e locus to cross τ locus once and only

• nce from below:

lim

e→0 he(aM, e) = ∞,

lim

e→1 he(aM, e) = 0

−V o

τe

V o

ττ

dτo de

• aM

< βbheepw

• aM
• dτ

deM

Alternative Case: Rapid Liberalization

Median voter becomes less protectionist due to shock

Back to Baseline Overshooting Case

Voters’ Trade Policy Preferences

Income: Io

t (a) =

1

• base rate

+ xs(h(a, et−1(a)))pt

• skill premium

+ R(τt)

tariff revenue

Optimal Policy: τ o(a; et−1(a)) = arg max

τt

V o pt, Io

t (a, et−1)

• (4)

FOC: Vτ(a) = vI

• [Es

t (a) − ¯

Es

t ]

• ≡∆t(a)

∂pt ∂τt

• (−)
• individual bias

+ tpdEs

t

dτt

= 0 @ t=0

• std optimal tariff

= 0. (5)

Back to Model

Protectionist Sentiment on the Rise?

Survey Question: “In general, do you think that free trade agreements between the United States and foreign countries have helped the United States, have hurt the United States, or have not made much of a difference either way?” Results: December 1999: 39% Helped vs. 30% Hurt March 2007: 28% Helped vs. 46% Hurt September 2010: 17% Helped vs. 53% Hurt ⋄ Key feature: The recent converts have college + education

–Wall Street Journal, “Americans Sour on Trade,” 10/4/10 (pg. A1)

Vox Populi:

Near Universal Protection for Lower-Wage Workers

Source: Lu, Scheve, Slaughter AJPS 2012

Caveat: Rhetoric vs. Policy in Practice

Despite impassioned speeches from the House floor... “We can’t continue to sit on our hands while Chinese businesses undercut American workers and our manufacturing base continues to drift overseas.”

–Representative Bill Pascrell Jr. March 6, 2012 (H1169)

...the data suggest other forces at play...

Despite the Rhetoric...

Decreasing Output, Falling Tariffs, Rising Imports of U.S. Manufacturing

0 ¡ 0.5 ¡ 1 ¡ 1.5 ¡ 2 ¡ 2.5 ¡ 3 ¡ 3.5 ¡ 4 ¡ 4.5 ¡ 5 ¡ ¡-­‑ ¡ ¡ ¡ ¡ ¡2.00 ¡ ¡ ¡4.00 ¡ ¡ ¡6.00 ¡ ¡ ¡8.00 ¡ ¡ ¡10.00 ¡ ¡ ¡12.00 ¡ ¡ ¡14.00 ¡ ¡ ¡16.00 ¡ ¡ ¡18.00 ¡ ¡ ¡20.00 ¡ ¡

Y e a r ¡ 1 9 8 ¡ 1 9 8 1 ¡ 1 9 8 2 ¡ 1 9 8 3 ¡ 1 9 8 4 ¡ 1 9 8 5 ¡ 1 9 8 6 ¡ 1 9 8 7 ¡ 1 9 8 8 ¡ 1 9 8 9 ¡ 1 9 9 ¡ 1 9 9 1 ¡ 1 9 9 2 ¡ 1 9 9 3 ¡ 1 9 9 4 ¡ 1 9 9 5 ¡ 1 9 9 6 ¡ 1 9 9 7 ¡ 1 9 9 8 ¡ 1 9 9 9 ¡ 2 ¡ 2 1 ¡ 2 2 ¡ 2 3 ¡ 2 4 ¡ 2 5 ¡ 2 6 ¡ 2 7 ¡ 2 8 ¡ 2 9 ¡ 2 1 ¡

Weighted ¡Average ¡Tariff ¡ ¡ Manufacturing ¡as ¡Percent ¡of ¡Imports/GDP ¡

Manufacturing ¡Imports ¡(% ¡of ¡GDP) ¡ Manufacturing ¡Value ¡Added ¡(% ¡of ¡GDP) ¡ Average ¡Applied ¡Tariff ¡Rate ¡(All ¡Products) ¡ Average ¡Applied ¡Tariff ¡Rate ¡(Manufacturing) ¡

Source: World Bank Statistics (DataBank)

Protectionism Since the 2008 Crisis

Not a return to Smoot-Hawley... but only thanks to WTO bindings, etc.?

Source: Bown (2011) Back

Alternative Case

Increasing Protectionism

Alternative Case

Increasing Protectionism

Developing Country Case:

Comparative advantage in U; human capital returns skewed to top as in North

Developing Country Case:

Response to ↑ pw: eM(τ) shifts right/up

Developing Country Case:

Response to ↑ pw: τ(eM) pivots counterclockwise

Developing Country Case:

Transition Dynamics for Liberal Overshooting

Developing Country Case:

Time Path of Policy Response