Unequal Gains, Prolonged Pain A Model of Protectionist Overshooting - - PowerPoint PPT Presentation

Unequal Gains, Prolonged Pain

A Model of Protectionist Overshooting and Escalation Emily J. Blanchard Gerald Willmann

Tuck at Dartmouth & CEPR

• U. Bielefeld & IFW Kiel

April 2019

Brexit, Trump, Le Pen, AfD, Conte, Bolsanaro, AMLO...

Brexit, Trump, Le Pen, AfD, Conte, Bolsanaro, AMLO...

What’s driving this surge in economic nationalism? Is this a temporary shift or the new normal? Will domestic policy interventions dampen support for protectionism? How about international agreements and rules? We build a model of short-run and long-run drivers of economic nationalism, then use the model as a guide to read the tea leaves.

Motivating Observation

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 – and the potential

for differences in economic vs. political frictions – seriously.

⇒ Most political economy models are static, steady state, or “rigged” to ensure smooth transitions between steady states, and so miss key features of dynamic adjustment.

Overview of Approach

This paper:

1 Develops a dynamic political economy model where policy

can adjust quickly, but economic adjustment takes longer.

2 Characterizes a salient political environment:

• Labor market adjustment to global price shocks and SBTC;
• 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 Considers ameliorating potential (or not) of redistribution

and education policy interventions.

5 Examines key data markers suggested by theory.

Preview of Results

Implications of the Theory

1 Unequal Gains ⇒ Prolonged Pain:

• If returns to openness are skewed toward the top,

↓ world price of low skill goods ⇒ Protectionist Surge.

• Magnitude and longevity ↑ w. initial inequality

2 Long run outcome hinges on whether rising skill premium

and education increases or decreases inequality.

• Convergence ⇒ Overshooting; Divergence ⇒ Escalation

3 Along the way:

• SBTC and TOT are shocks essentially isomorphic.
• ‘Complex redistribution’ necessary to defuse protectionism,

but blunts incentives ⇒ fundamental tension.

• Education policy removes tension, but risks divergence.
• Safeguards are essential under overshooting.

4 Key data markers: mean vs. median gap; stickiness

• U.S./U.K. data suggestively different

Remainder of Talk

Related Literature Model

• Case 1: Protectionist Overshooting
• Case 2: Protectionist Escalation

Bonus implications: SBTC, redistribution, safeguards 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 median voter is less skilled than ‘average’ ⇒ Protectionist Surge

Sketch of the Model

Individuals and Education Continuum of heterogenous agents live for 2 periods Agents born with innate advantage, 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 advantage → human capital, h ≡ h(a, e) s.t.: ha > 0 he > 0 hee < 0 hae > 0

Sketch of Model, cont.

Production and Trade SOE with two goods: U, basic numeraire and S, skill-based U: one-for-one in unskilled labor → unskilled wage =1 S: x(h) ≡ bh where b > 0 (↑ b ≈ SBTC) Assume our economy has comparative advantage in S Total return to human capital: xp = bhp, where p ≡ pw

τ

⇒ Trade liberalization increases returns to education Preferences Identical, homothetic, additively separable across time: u(dy

u, dy s) + βu(do u, do s)

where β > 0 and u(du, ds) ≡ d(1−α)

u

dα

s

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; τt, τt+1) is

• increasing in initial advantage (single crossing)
• increasing in current & future domestic 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: V o

τ (a) = vI

• [Eo,s

t (a) − ¯

Eo,s

t ]

• ≡∆t(a;et−1)

∂pt ∂τt

• (−)
• individual bias

+ ttpt d ¯ Eo,s

t

dτt

• = 0 @ t=0
• std optimal tariff

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

Politics

Equilibrium Trade Policy, τt = τ(aM; et−1) Determined by education of median voter born in previous generation; Decreasing in ∆m

t ≡ ∆(aM, et−1); i.e. the median voter’s

human capital relative to the mean in her 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; et−1), 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, et−1)) = ˜

τ; ∀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}, where: ˜ e(a) = e(a, ˜ τ) = h−1

e

• a,

˜ τ βbpw

• ∀a

˜ τ = T(˜ eM, et−1) = arg max

τ

V o(τ; aM, ˜ eM, et−1).

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

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 – first, 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 ; et)

Median voter’s education stuck at T, then rises at T + 1 Can prove that tariff spike offers partial protection, i.e. pT > ˜ p, which implies eT+1(a) > ˜ e(a) ∀a. Thereafter, et = e(aM; τt, τt+1)

Immediate Affect of ↑ pw:

˜ eM stuck at T: unambiguously, τT ↑ (but pT ≡ pw′

τT ↑ and thus eT ↑)

Permanent Protectionism or Temporary Setback?

Depends on whether ∆(aM) is falling or rising with education/skill premium

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.

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)

Protectionist Escalation:

Occurs if the mean-median gap rises with the skill-premium d∆(aM)

dp

< 0

Protectionist Escalation:

Political Pendulum, Oscillating Convergence

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 @T, ∆M ↑ ⇒ tariffs fall and education continues to rise. ˜ ˜ τ < τT .

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

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

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. Why? Recall FOC of optimal tariff problem: Vτ(a) = vI

• ∆t(a)∂pt

∂τt

• individual bias

+tpdEs

t

dτt

• = 0 (2)
• −(1 − α)(h(a) − ¯

h)bpw(1/τ 2)

(3)

Additional Implications of the Model

2 “Simple Redistribution” may not defuse protectionism.

⇒ Protectionism falls iff the median voter’s preferences over domestic prices are more closely aligned with the overall economy. ⇒ First best ‘politically viable’ instruments to defuse protectionism must enter the median voter’s FOC wrt tariffs. ⇒ But any instrument that enters voters’ FOCs risks blunting incentives (here, over education): correcting a “political distortion” introduces an economic distortion.

Additional Implications of the Model

3 Educational subsidies and reforms can defuse protectionism

in the short and long run, but they need to induce convergence. Many do not.

Additional Implications of the Model

4 When protectionist surges are only temporary (under

Overshooting), escape clauses/safeguards may be essential to avoid permanent protectionism via a trade war.

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 Unique, Stable, Interior Steady State: ( h2

e

hee |am −

• a

h2

e

hee f(a)da) < τ 2 pw

• ¯

h +

1 bpw

• (α(τ − αt)),

(4) ∆m(τ)

• τ=1 < 0 and ∆m(τ)
• τ P > τ −1(∆m)
• τ P .

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 + bh(a, et−1(a))pt

• skill premium

+ ttptEo,s

t

tariff revenue

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

τt

V o pt, Io

t (a, et−1)

• (5)

FOC: Vτ(a) = vI

• [Es

t (a) − ¯

Es

t ]

• ≡∆t(a)

∂pt ∂τt

• (−)
• individual bias

+ tpd ¯ Es

t

dτt

= 0 @ t=0

• std optimal tariff

= 0. (6)

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 Visualization

Overshooting in {∆, τ} Space

Alternative Visualization

Escalation in {∆, τ} Space