Creative Construction: "The stereotype is that American students aren't very well-trained technically and thus do poorly when tested in areas such as math and science, but their intuitive skills are fairly well developed. Foreign students are just the opposite according to this view, excellent technically, but less able to express the intuitive reasoning behind the mathematics or the science and less able to use intuitive skills to combine ideas creatively. The difference is generally attributed to a difference in emphasis in education with foreign students far more devoted to rote learning than their American counterparts. While this gives Americans a disadvantage in engineering, computer programming, and so on, they are much more likely to come up with innovative new ideas. Or so the story goes. Is this is really true? India and China believe it and are wondering how to change their educational systems to encourage more creativity:

Worried About India's and China's Booms? So Are They, by Thomas L. Friedman, Commentary, NY Times: The more I ... travel, the more I find that the most heated debates in many countries are around education. ... every country thinks it's behind. ... America agonizes that its ... public schools badly need improvement in math and science. I was just in Mumbai attending the annual meeting of India's high-tech association, ... where many speakers worried aloud that Indian education wasn't nurturing enough "innovators."

Both India and China, which have mastered rote learning and have everyone else terrified about their growing armies of engineers, are wondering if too much math and science — unleavened by art, literature, music and humanities — aren't making Indira and Zhou dull kids and not good innovators. Very few global products have been spawned by India or China.

"We have ... everyone going into engineering and M.B.A.'s," said Jerry Rao, chief executive of ... one of the top Indian outsourcing companies. "If we don't have enough people with the humanities, we will lose the [next generation of] V. S. Naipauls and Amartya Sens," he added, referring to the Indian author and the Indian economist, both Nobel laureates. ...

Innovation is often a synthesis of art and science, and the best innovators often combine the two. The Apple co-founder Steve Jobs ... recalled how he dropped out of college but stuck around campus and took a calligraphy course, where he learned about the artistry of great typography. "None of this had even a hope of any practical application in my life," he recalled. "But 10 years later, when we were designing the first Macintosh computer, it all came back to me. And we designed it all into the Mac. It was the first computer with beautiful typography." ...

Capital will now flow faster than ever to tap the most productive talent wherever it is located ... Hence the concern I found in India that it must move quickly from business process outsourcing ... into knowledge process outsourcing ... coming up with more original designs and products.

"We need to encourage more incubation of ideas ... to make innovation a national initiative," said Azim Premji, the chairman of ... one of India's premier technology companies. "Are we as Indians creative? Going by our rich cultural heritage, we have no doubt some of the greatest art and literature. We need to bring the same spirit into our economic and business arena."

But to make that leap, Indian entrepreneurs say, will require a big change in the rigid, never-challenge-the-teacher Indian education system. "If we do not allow our students to ask why, but just keep on telling them how, then we are only going to get the transactional type of outsourcing..." said Nirmala Sankaran C.E.O. of ... an Indian-based education company. "We have a creative problem in this country."...

"

Amartya Sen: Democracy Isn't 'Western': "Amartya Sen, a Nobel laureate in economics discusses the deception of using cultural differences between countries as an explanation of economic and political differences, in particular as an explanation for the emergence of democracy in some countries, but not in others:



Democracy Isn't 'Western', by Amartya Sem, Commentary, WSJ: 'The fault, dear Brutus, is not in our stars, but in ourselves, that we are underlings.' Culture too, like our stars, is often blamed for our failures. Attempts to build a better world capsize, it is alleged, in the high sea of cultural resistance. The determinism of culture is increasingly used in contemporary global discussions to generate pessimism about the feasibility of a democratic state, or of a flourishing economy, or of a tolerant society, wherever these conditions do not already obtain.

Indeed, cultural stereotyping can have great effectiveness in fixing our way of thinking. When there is an accidental correlation between cultural prejudice and social observation (no matter how casual), a theory is born, and it may refuse to die even after the chance correlation has vanished without trace. For example, labored jokes against the Irish, which have had such currency in England, had the superficial appearance of fitting well with the depressing predicament of the Irish economy when it was doing quite badly. But when the Irish economy started growing astonishingly rapidly, for many years faster than any other European economy, the cultural stereotyping and its allegedly profound economic and social relevance were not junked as sheer rubbish. Theories have lives of their own, quite defiantly of the phenomenal world that can be actually observed.

Many have observed that in the '60s South Korea and Ghana had similar income per head, whereas within 30 years the former grew to be 15 times richer than the latter. This comparative history is immensely important to study and causally analyze, but the temptation to put much of the blame on Ghanaian or African culture (as is done by as astute an observer as Samuel Huntington) calls for some resistance. Mr. Huntington closes his contrast with a spectacular formula: "South Koreans valued thrift, investment, hard work, education, organization and discipline. Ghanaians had different values. In short, cultures count." Ghanaians, and perhaps many other Africans, seem doomed to stagnate, according to this analysis.

In fact, that cultural story is extremely deceptive. There were many important differences, other than any differences in cultural predispositions, between Ghana and Korea in the 1960s. First, the class structures in the two countries were quite different, with a very much bigger -- and proactive -- role of business classes in Korea. Second, the politics were very different, too, with the government in South Korea eager to play a prime-moving role in initiating societal reform and economic development in a way that was not true in Ghana. Third, the close relationship between the Korean economy and Japan, on the one hand, and the U.S., on the other, made a big difference, at least in the early stages of Korean economic expansion.

Fourth -- and perhaps most important -- by the 1960s South Korea had acquired a much higher literacy rate and a much more expanded school system than Ghana had. Korean massive progress in school education had been largely brought about in the post-World War II period, mainly through resolute public policy, and it could not be seen just as a reflection of cultural difference. This is not to suggest that cultural factors are irrelevant to the process of development, but they do not work in isolation from social, political and economic influences. Nor are they immutable.

The temptation of founding economic pessimism on cultural resistance is matched by the evident enchantment, even more common today, of basing political pessimism, particularly about democracy, on alleged cultural impossibilities. While it is easy enough to understand the widespread -- and increasing -- doubts about armed intervention allegedly aimed at jump-starting democracy in Iraq through largely foreign and military planning, it would be quite a leap from there to become skeptical of the general possibility of the emergence of democracy in any country that is currently nondemocratic. It is worth remembering that democracy has developed well enough in many countries in Asia, Africa and Latin America, and in the case of some, such as South Africa, even foreign assistance to local democratic movements (for example through economic boycott) has positively helped.

When it is asked whether Western countries can "impose" democracy on the non-Western world, even the language reflects a confusion centering on the idea of "imposition," since it implies a proprietary belief that democracy "belongs" to the West, taking it to be a quintessentially "Western" idea which has originated and flourished exclusively in the West. This is a thoroughly misleading way of understanding the history and the contemporary prospects of democracy.

Democracy, to use the old Millian phrase, is "government by discussion," and voting is only one part of a broader picture (an understanding that has, alas, received little recognition in post-intervention Iraq in the attempt to get straight to polling without the development of broad public reasoning and an independent civil society). There can be no doubt at all that the modern concepts of democracy and of public reasoning have been very deeply influenced by European and American analyses and experiences over the last few centuries (including the contributions of such theorists of democracy as Marquis de Condorcet, Jefferson, Madison and Tocqueville). But to extrapolate backward from these comparatively recent experiences to construct a quintessential and long-run dichotomy between the West and non-West would be deeply misleading. There is a long history of public reasoning across the world, and while it has gone through ups and downs everywhere, the sharp priority of liberal tolerance that has emerged in the West over the past three centuries reflects how social evolution can strengthen and consolidate one tendency to the exclusion -- or near exclusion -- of other tendencies.

The belief in the allegedly "Western" nature of democracy is often linked to the early practice of voting and elections in Greece, especially in Athens. Democracy involves more than balloting, but even in the history of voting there would be a classificatory arbitrariness in defining civilizations in largely racial terms. In this way of looking at civilizational categories, no great difficulty is seen in considering the descendants of, say, Goths and Visigoths as proper inheritors of the Greek tradition ("they are all Europeans," we are told). But there is reluctance in taking note of the Greek intellectual links with other civilizations to the east or south of Greece, despite the greater interest that the Greeks themselves showed in talking to Iranians, or Indians, or Egyptians (rather than in chatting up the Ostrogoths).

Since traditions of public reasoning can be found in nearly all countries, modern democracy can build on the dialogic part of the common human inheritance. In his autobiography, Nelson Mandela describes how influenced he was, as a boy, by seeing the democratic nature of the proceedings of the meetings that were held in his home town: "Everyone who wanted to speak did so. It was democracy in its purest form. There may have been a hierarchy of importance among the speakers, but everyone was heard, chief and subject, warrior and medicine man, shopkeeper and farmer, landowner and laborer." Mr. Mandela could combine his modern ideas about democracy with emphasizing the supportive part of the native tradition, in a way that Gandhi had done in India, and that is the way cultures adapt and develop to respond to modernity. Mr. Mandela's quest for democracy and freedom did not emerge from any Western "imposition."

Similarly, the history of Muslims includes a variety of traditions, not all of which are just religious or "Islamic" in any obvious sense. The work of Arab and Iranian mathematicians, from the eighth century onward reflects a largely nonreligious tradition. Depending on politics, which varied between one Muslim ruler and another, there is also quite a history of tolerance and of public discussion, on which the pursuit of a modern democracy can draw. For example, the emperor Saladin, who fought valiantly for Islam in the Crusades in the 12th century, could offer, without any contradiction, an honored place in his Egyptian royal court to Maimonides, as that distinguished Jewish philosopher fled an intolerant Europe. When, at the turn of the 16th century, the heretic Giordano Bruno was burned at the stake in Campo dei Fiori in Rome, the Great Mughal emperor Akbar (who was born a Muslim and died a Muslim) had just finished, in Agra, his large project of legally codifying minority rights, including religious freedom for all, along with championing regular discussions between followers of Islam, Hinduism, Jainism, Judaism, Zoroastrianism and other beliefs (including atheism).

Cultural dynamics does not have to build something from absolutely nothing, nor need the future be rigidly tied to majoritarian beliefs today or the power of the contemporary orthodoxy. To see Iranian dissidents who want a fully democratic Iran not as Iranian advocates but as "ambassadors of Western values" would be to add insult to injury, aside from neglecting parts of Iranian history (including the practice of democracy in Susa or Shushan in southwest Iran 2,000 years ago). The diversity of the human past and the freedoms of the contemporary world give us much more choice than cultural determinists acknowledge. This is particularly important to emphasize since the illusion of cultural destiny can extract a heavy price in the continued impoverishment of human lives and liberties.

"

Amartya Sen: Democracy Isn't 'Western': "Amartya Sen, a Nobel laureate in economics discusses the deception of using cultural differences between countries as an explanation of economic and political differences, in particular as an explanation for the emergence of democracy in some countries, but not in others:



Democracy Isn't 'Western', by Amartya Sem, Commentary, WSJ: 'The fault, dear Brutus, is not in our stars, but in ourselves, that we are underlings.' Culture too, like our stars, is often blamed for our failures. Attempts to build a better world capsize, it is alleged, in the high sea of cultural resistance. The determinism of culture is increasingly used in contemporary global discussions to generate pessimism about the feasibility of a democratic state, or of a flourishing economy, or of a tolerant society, wherever these conditions do not already obtain.



ndeed, cultural stereotyping can have great effectiveness in fixing our way of thinking. When there is an accidental correlation between cultural prejudice and social observation (no matter how casual), a theory is born, and it may refuse to die even after the chance correlation has vanished without trace. For example, labored jokes against the Irish, which have had such currency in England, had the superficial appearance of fitting well with the depressing predicament of the Irish economy when it was doing quite badly. But when the Irish economy started growing astonishingly rapidly, for many years faster than any other European economy, the cultural stereotyping and its allegedly profound economic and social relevance were not junked as sheer rubbish. Theories have lives of their own, quite defiantly of the phenomenal world that can be actually observed.

Many have observed that in the '60s South Korea and Ghana had similar income per head, whereas within 30 years the former grew to be 15 times richer than the latter. This comparative history is immensely important to study and causally analyze, but the temptation to put much of the blame on Ghanaian or African culture (as is done by as astute an observer as Samuel Huntington) calls for some resistance. Mr. Huntington closes his contrast with a spectacular formula: "South Koreans valued thrift, investment, hard work, education, organization and discipline. Ghanaians had different values. In short, cultures count." Ghanaians, and perhaps many other Africans, seem doomed to stagnate, according to this analysis.

In fact, that cultural story is extremely deceptive. There were many important differences, other than any differences in cultural predispositions, between Ghana and Korea in the 1960s. First, the class structures in the two countries were quite different, with a very much bigger -- and proactive -- role of business classes in Korea. Second, the politics were very different, too, with the government in South Korea eager to play a prime-moving role in initiating societal reform and economic development in a way that was not true in Ghana. Third, the close relationship between the Korean economy and Japan, on the one hand, and the U.S., on the other, made a big difference, at least in the early stages of Korean economic expansion.

Fourth -- and perhaps most important -- by the 1960s South Korea had acquired a much higher literacy rate and a much more expanded school system than Ghana had. Korean massive progress in school education had been largely brought about in the post-World War II period, mainly through resolute public policy, and it could not be seen just as a reflection of cultural difference. This is not to suggest that cultural factors are irrelevant to the process of development, but they do not work in isolation from social, political and economic influences. Nor are they immutable.

The temptation of founding economic pessimism on cultural resistance is matched by the evident enchantment, even more common today, of basing political pessimism, particularly about democracy, on alleged cultural impossibilities. While it is easy enough to understand the widespread -- and increasing -- doubts about armed intervention allegedly aimed at jump-starting democracy in Iraq through largely foreign and military planning, it would be quite a leap from there to become skeptical of the general possibility of the emergence of democracy in any country that is currently nondemocratic. It is worth remembering that democracy has developed well enough in many countries in Asia, Africa and Latin America, and in the case of some, such as South Africa, even foreign assistance to local democratic movements (for example through economic boycott) has positively helped.

When it is asked whether Western countries can "impose" democracy on the non-Western world, even the language reflects a confusion centering on the idea of "imposition," since it implies a proprietary belief that democracy "belongs" to the West, taking it to be a quintessentially "Western" idea which has originated and flourished exclusively in the West. This is a thoroughly misleading way of understanding the history and the contemporary prospects of democracy.

Democracy, to use the old Millian phrase, is "government by discussion," and voting is only one part of a broader picture (an understanding that has, alas, received little recognition in post-intervention Iraq in the attempt to get straight to polling without the development of broad public reasoning and an independent civil society). There can be no doubt at all that the modern concepts of democracy and of public reasoning have been very deeply influenced by European and American analyses and experiences over the last few centuries (including the contributions of such theorists of democracy as Marquis de Condorcet, Jefferson, Madison and Tocqueville). But to extrapolate backward from these comparatively recent experiences to construct a quintessential and long-run dichotomy between the West and non-West would be deeply misleading. There is a long history of public reasoning across the world, and while it has gone through ups and downs everywhere, the sharp priority of liberal tolerance that has emerged in the West over the past three centuries reflects how social evolution can strengthen and consolidate one tendency to the exclusion -- or near exclusion -- of other tendencies.

The belief in the allegedly "Western" nature of democracy is often linked to the early practice of voting and elections in Greece, especially in Athens. Democracy involves more than balloting, but even in the history of voting there would be a classificatory arbitrariness in defining civilizations in largely racial terms. In this way of looking at civilizational categories, no great difficulty is seen in considering the descendants of, say, Goths and Visigoths as proper inheritors of the Greek tradition ("they are all Europeans," we are told). But there is reluctance in taking note of the Greek intellectual links with other civilizations to the east or south of Greece, despite the greater interest that the Greeks themselves showed in talking to Iranians, or Indians, or Egyptians (rather than in chatting up the Ostrogoths).

Since traditions of public reasoning can be found in nearly all countries, modern democracy can build on the dialogic part of the common human inheritance. In his autobiography, Nelson Mandela describes how influenced he was, as a boy, by seeing the democratic nature of the proceedings of the meetings that were held in his home town: "Everyone who wanted to speak did so. It was democracy in its purest form. There may have been a hierarchy of importance among the speakers, but everyone was heard, chief and subject, warrior and medicine man, shopkeeper and farmer, landowner and laborer." Mr. Mandela could combine his modern ideas about democracy with emphasizing the supportive part of the native tradition, in a way that Gandhi had done in India, and that is the way cultures adapt and develop to respond to modernity. Mr. Mandela's quest for democracy and freedom did not emerge from any Western "imposition."

Similarly, the history of Muslims includes a variety of traditions, not all of which are just religious or "Islamic" in any obvious sense. The work of Arab and Iranian mathematicians, from the eighth century onward reflects a largely nonreligious tradition. Depending on politics, which varied between one Muslim ruler and another, there is also quite a history of tolerance and of public discussion, on which the pursuit of a modern democracy can draw. For example, the emperor Saladin, who fought valiantly for Islam in the Crusades in the 12th century, could offer, without any contradiction, an honored place in his Egyptian royal court to Maimonides, as that distinguished Jewish philosopher fled an intolerant Europe. When, at the turn of the 16th century, the heretic Giordano Bruno was burned at the stake in Campo dei Fiori in Rome, the Great Mughal emperor Akbar (who was born a Muslim and died a Muslim) had just finished, in Agra, his large project of legally codifying minority rights, including religious freedom for all, along with championing regular discussions between followers of Islam, Hinduism, Jainism, Judaism, Zoroastrianism and other beliefs (including atheism).

Cultural dynamics does not have to build something from absolutely nothing, nor need the future be rigidly tied to majoritarian beliefs today or the power of the contemporary orthodoxy. To see Iranian dissidents who want a fully democratic Iran not as Iranian advocates but as "ambassadors of Western values" would be to add insult to injury, aside from neglecting parts of Iranian history (including the practice of democracy in Susa or Shushan in southwest Iran 2,000 years ago). The diversity of the human past and the freedoms of the contemporary world give us much more choice than cultural determinists acknowledge. This is particularly important to emphasize since the illusion of cultural destiny can extract a heavy price in the continued impoverishment of human lives and liberties. "

Transportation Costs and Globalization: "Changes in transportation technology have reduced transportation costs substantially helping to fuel the globalization process. Since digital technology is also a means of reducing transportation costs - email is cheaper and faster than air mail - globalization has been facilitated by the ability to move goods and services across borders at a reduced cost. Virginia Postrel discusses the sharp decline in international shipping costs in her last Economic Scene for the New York Times:



The Container That Changed the World By Virginia Postrel, Economic Scene, NY Times: The political showdown over a Dubai company's plan to operate terminals at six American ports briefly focused public attention on one of the most significant, yet least noticed, economic developments of the last few decades: the transformation of international shipping. Just as the computer revolutionized the flow of information, the shipping container revolutionized the flow of goods. ... By sharply cutting costs and enhancing reliability, container-based shipping enormously increased the volume of international trade and made complex supply chains possible.

'Low transport costs help make it economically sensible for a factory in China to produce Barbie dolls with Japanese hair, Taiwanese plastics and American colorants, and ship them off to eager girls all over the world,' writ"

The Foreign Direct Investment Behavior of Multinational Corporations: "A colleague, Bruce Blonigen, writing in the NBER Reporter on the determinants of foreign direct investment by multinational corporations:



Foreign Direct Investment Behavior of Multinational Corporations, by Bruce A. Blonigen, NBER Reporter: There is increasing recognition that understanding the forces of economic globalization requires looking first at foreign direct investment (FDI) by multinational corporations (MNCs): that is, when a firm based in one country locates or acquires production facilities in other countries. While real world GDP grew at a 2.5 percent annual rate and real world exports grew by 5.6 percent annually from 1986 through 1999, United Nations data show that real world FDI inflows grew by 17.7 percent over this same period! Additionally, MNCs mediate most world trade flows. For example, Bernard, Jensen, and Schott find that 90 percent of U.S. exports and imports flow through a U.S. MNC, with roughly 50 percent of U.S. trade flows occurring between affiliates of the same MNC, or what is termed intra-firm trade (1)

Despite the obvious importance of FDI and MNCs in the world economy, research on the factors that determine FDI patterns and the impact of MNCs on parent and host countries is in its early stages. The most important general questions are: what factors determine where FDI occurs, and what impacts do those MNC operations have on the parent and host economies? As I discuss in a recent survey of the empirical literature addressing the first question -- the determinants of FDI decisions -- the answers are not straightforward.⁽²⁾ In particular, the literature has shown that we cannot simply conclude that factors such as exchange rates or tax policies have an unambiguous general impact on FDI patterns. Instead, meaningful insights come from developing hypotheses about, say, when a factor should matter for FDI, or even just a particular form of FDI, and then finding creative ways to test these hypotheses in the data.

Exchange Rates and FDI

One good example of this is the effect of exchange rate movements on FDI. For years, the conventional theory was to compare FDI to bonds, for which exchange rate movements do not affect the investment decision. A depreciation of the currency in the host country reduces the amount of foreign currency needed to purchase the asset, but it also reduces the nominal return one receives in the foreign currency. Thus, the rate of return for the foreign investor does not change. Empirical studies of FDI seemed to confirm this, often finding insignificant effects of exchange rates. In contradiction to this, the popular press often points to host-country exchange rate depreciations as a contributing factor to inward foreign investment booms, and worries about the selling of key national technological assets.

I find a resolution to this puzzle by considering FDI that involves firm-specific assets (such as patents or managerial skills) - the type of assets previous literature established as crucial to formation of MNCs and FDI.⁽³⁾ Such assets are typically intangible and easily transferred across a firm's operations. Thus, the purchase prices of such assets through FDI are in the host-country's currency, but returns can be generated anywhere the firm operates and are not necessarily tied to the home country's currency. This means that host-country currency depreciations theoretically can lead to increased acquisition of FDI, particularly of firms that have firm-specific assets. This hypothesis is strongly confirmed for a panel of acquisitions of U.S. firms by Japanese and German firms and provides evidence for the notion in the popular press that currency depreciations ease foreign firms' purchases of U.S. host-country technological assets.

Taxes and FDI

Another factor that the literature finds does not affect FDI in a straightforward manner is tax policy. MNCs are potentially subject to taxation in both the host and parent country. However, most parent countries have policies to reduce or eliminate double taxation of their MNCs. James R. Hines, Jr. and co-authors have shown that the way in which parent countries reduce double taxation on their MNCs (for example, allowing credits or deductions) can have quite different implications for FDI activity.⁽⁴⁾

Many countries also have negotiated bilateral investment treaties (BITs) to mutually reduce withholding taxes on MNCs based in the other country. The Organisation for Economic Co-operation and Development (OECD) has been a big advocate of BITs as a way to enhance FDI across member countries. Others contend that BITs are mainly intended to share tax information across countries in order to deter tax evasion and to reduce administrative costs and, thus, should have little, or even negative, effects on FDI flows.⁽⁵⁾ Ron B. Davies and I examine whether the empirical evidence suggests that such treaties increase FDI flows across nations, as the OECD and many economists presume.⁽⁶⁾ In separate studies, we examine the evidence for the U.S. and for OECD BITs, respectively, in panel data that span a variety of bilateral country pairs over time. Across these various samples and numerous specifications, we find little evidence that these BITs increase FDI activity, a surprising result in light of OECD promotion of these treaties.

Trade Protection and FDI

The notion that trade protection encourages FDI is folk wisdom for economists, so much so that it is rarely examined empirically. But my research into this relationship has also yielded surprises. In a study examining all U.S. antidumping trade protection actions from 1980 through 1995, I find that FDI responses to these trade actions (tariff-jumping FDI) occur only for firms with previous experience as MNCs.⁽⁷⁾ Most firms facing such trade policies (many from developing countries) have no such experience and do not respond with FDI. Instead, these firms must face either significant antidumping duties or go through the costly process of raising U.S. prices and requesting recalculations of the duties.⁽⁸⁾ For domestic firms, whether foreign firms tariff-jump the antidumping duties matters significantly. Work with Tomlin and Wilson finds that domestic firms experience a 3 percent increase in expected discounted profitability from antidumping duties unless the foreign firms subject to the duties decide to tariff-jump, in which case the domestic firms do not experience any increase.⁽⁹⁾,⁽¹⁰⁾

Information and FDI

An almost unexplored issue in the literature has been the role of information on FDI decisions. FDI requires substantial fixed costs of identifying an efficient location, acquiring knowledge of the local regulatory environment, and coordination of suppliers. Thus, access to better information about some host countries may make FDI to that location more likely. Ellis, Fausten, and I find an interesting avenue for investigating this hypothesis using information on Japanese industrial groups called keiretsu.⁽¹¹⁾ Horizontal keiretsu are groups of firms across a wide range of industries, typically centered around a main bank that owns significant shares in these firms. A number of studies have focused on the potentially favorable financing received by keiretsu firms from their main bank as one impetus for greater investment by these firms, including FDI -- but the evidence is mixed on this. However, the major firms in a keiretsu also get together on a regular basis in what are termed Presidential Meetings and presumably share information more than other firms would. My work with Ellis and Fausten examines whether this information affects FDI choices, by estimating how much prior-year FDI by members of a firm's keiretsu in a particular host country increases the likelihood that the firm will also choose that country for its FDI. We find that prior-year investment by a firm in the same keiretsu will raise a firm's probability of locating an investment in that same host country by about 20 percent.

A related paper with Wooster examines whether U.S. firms increase overseas investments when a new CEO who is foreign-born takes over.⁽¹²⁾ Our examination of CEO turnover among Fortune 500 firms in the 1990s does show evidence of significant increases in FDI when a "foreign" CEO takes over. It is difficult to disentangle whether such an effect is attributable to better information of foreign markets by the foreign CEO or to different personal preferences influenced by a less U.S.-centric perspective. Regardless, the results suggest that there are likely other important factors behind FDI patterns than the standard economic ones so often mentioned in the literature.

Estimating Long-Run General-Equilibrium Determinants of FDI

Much of the literature described to this point motivates analysis with partial equilibrium models of individual firm-level FDI decisions. But we also want to have empirical specifications of FDI that are grounded in theory and that do a good job of explaining FDI patterns across the world. Researchers looking at world FDI patterns have generally used variations of a gravity framework to model FDI, specifying parent- and host-country GDPs along with distance as core determinants of FDI. These models seemingly do well to describe FDI patterns statistically, but while Anderson and van Wincoop have solidified an appropriate gravity specification as theoretically valid for trade patterns, it is not clear this is true for FDI patterns.⁽¹³⁾

Of course, deriving a theoretically based empirical specification of FDI is a fairly complicated problem. General equilibrium theoretical models of MNCs and their FDI activities only first began to be developed in the mid-1980s with Markusen's development of a horizontal model of FDI where an MNC replicates its process across multiple countries to avoid trade frictions, and Helpman's vertical MNC model where firms locate their production process abroad to take advantage of lower factor costs.⁽¹⁴⁾ A recent important step by Carr, Markusen, and Maskus (CMM) was estimation of empirical specifications of FDI based on general equilibrium models of MNCs.⁽¹⁵⁾ Their work shows that other factors missing from gravity-based FDI specifications, particularly factor endowment differences, are important for explaining FDI patterns.

In recent work with co-authors I have explored the central question of how well these specifications actually fit the real-world data we observe. The empirical specification estimated by CMM was a starting point in this research, since its inclusion of endowment differences clearly outperforms a standard gravity equation of FDI. In initial work with the model, Davies, Head, and I found that the CMM model had a specification of endowment differences that was not consistent with the theory. Once corrected, the model no longer provides evidence that vertical FDI motivations are very important in overall FDI flows between countries.⁽¹⁶⁾ Work with Davies and Wang shows that specification error goes beyond this with not only the CMM model, but also with the gravity specification.⁽¹⁷⁾ Data on FDI between countries are highly skewed, with very large activity between developed countries and small or even no activity for very small countries. We show that even after logging variables, adding country fixed-effects, and splitting samples into developed countries versus less-developed countries, one is still not guaranteed of having normally distributed error terms. In other words, finding an appropriate specification that effectively models the substantial heterogeneity in FDI activity across countries is still an open issue. Until this is resolved, using these models as control variables in studies of how new factors of interest affect FDI can be misleading.

An additional concern is that MNC models typically use a two-country framework and empirical FDI specifications use bilateral FDI data. This assumes that FDI decisions to different markets are independent. There are a number of reasons to think this may not be true. For example, U.S. firms may prefer to locate FDI in one country and then export to neighboring countries (export-platform FDI). In this case, more FDI in a particular host country would mean less in neighboring ones. Alternatively, U.S. firms may have vertical production relationships between affiliates such that more FDI in a country will naturally be associated with more in neighboring ones because of production externalities. Davies, Naughton, Waddell, and I explore this by explicitly modeling spatial interdependence in empirical estimation of U.S. FDI patterns.⁽¹⁸⁾ We find that spatial interdependence shows up significantly in the data, although the nature of these spatial relationships is strongly affected by the particular geographic features of the sample of countries one chooses to examine. However, our finding that the coefficients on the standard control variables in FDI studies are hardly affected by including these spatial considerations is relatively good news for previous work using these empirical specifications.

Conclusion

The study of FDI and MNCs is both fascinating and important for understanding economic globalization. There has been substantial progress in the literature in the past couple of decades, but it is complicated enough that, in many ways, we are still in the process of uncovering what we don't know. I am excited to work on filling more gaps in our understanding in my future research efforts.

---

1. A.B. Bernard, J.B. Jensen, and P.K. Schott, "Importers, Exporters and Multinationals: A Portrait of the Firms in the U.S. that Trade Goods," NBER Working Paper No. 11404, June 2005.

2. B.A. Blonigen, "A Review of the Empirical Literature on FDI Determinants," NBER Working Paper No. 11299, May 2005, and forthcoming, Atlantic Economic Journal.

3. B.A. Blonigen, "Firm-Specific Assets and the Link Between Exchange Rates and Foreign Direct Investment," American Economic Review, 87(3), June 1997, pp. 447-65.

4. For example, see J.R. Hines, "Altered States: Taxes and the Location of Foreign Direct Investment in America," NBER Working Paper No. 4397, May 1997, and American Economic Review, 86(5), December 1996, pp. 1076-94, and M.A. Desai, C.F. Foley, and J.R. Hines, "Foreign Direct Investment in a World of Multiple Taxes," NBER Working Paper No. 8440, August 2001, and Journal of Public Economics, 88(12), December 2004, pp. 2727-44.

5. For example, see T. Dagan, "The Tax Treaties Myth," New York University Journal of International Law and Politics, Summer 2000, pp.939-96.

6. B.A. Blonigen and R.B. Davies, "The Effects of Bilateral Tax Treaties on U.S. FDI Activity," International Tax and Public Finance, 11(5), September 2004, pp. 601-22, and B.A. Blonigen and R.B. Davies, "Do Bilateral Tax Treaties Promote Foreign Direct Investment?" NBER Working Paper No. 8834, March 2002, and Handbook of International Trade, Volume II: Economic and Legal Analysis of Laws and Institutions, J. Hartigan, ed., Blackwell Publishers, 2005.

7. B.A. Blonigen, "Tariff-jumping Antidumping Duties," NBER Working Paper No. 7776, July 2000, and Journal of International Economics, 57(1), June 2002, pp. 31-50.

8. B.A. Blonigen, "Evolving Discretionary Practices of U.S. Antidumping Activity," NBER Working Paper No. 9625, April 2003, and, forthcoming, Canadian Journal of Economics, documents the rapidly rising trend in U.S. antidumping duties and the sources of this trend. B.A. Blonigen and S.E. Haynes, "Antidumping Investigations and the Pass-Through of Exchange Rates and Antidumping Duties," NBER Working Paper No. 7873, October 1999, and American Economic Review, 92(4), September 2002, pp. 1044-61, and B.A. Blonigen and J.-H. Park, " Dynamic Pricing in the Presence of Antidumping Policy: Theory and Evidence," NBER Working Paper No. 8477, September 2001, and American Economic Review, 94(1), March 2004, pp. 134-54, address the economics of firms' strategic pricing decisions in the face of antidumping duties.

9. B.A. Blonigen, K. Tomlin, and W.W. Wilson, "Tariff-jumping FDI and Domestic Firms' Profits," NBER Working Paper No. 9027, June 2002, and Canadian Journal of Economics, 37(3), August 2004, pp. 656-77.

10. A related issue is how FDI may affect trade protection policies (that is, reverse causality), which I address with co-authors in B.A. Blonigen and R.C. Feenstra, "Protectionist Threats and Foreign Direct Investment," NBER Working Paper No. 5475, March 1996, and in Effects of U.S. Trade Protection and Promotion Policies, R.C. Feenstra, ed.,Chicago: University of ChicagoPress, 1997, pp. 55-80, and B.A. Blonigen and D.N. Figlio, "Voting for Protection: Does Direct Foreign Investment Influence Legislator Behavior?" American Economic Review, 88(4), September 1998, pp. 1002-14.

11. B.A. Blonigen, C.J. Ellis, and D. Fausten, "Industrial Groupings and Foreign Direct Investment," Journal of International Economics, Vol. 65(1), January 2005, pp. 75-91 (An earlier version was circulated as "Industrial Groupings and Strategic FDI: Theory and Evidence" NBER Working Paper No. 8046, December 2000).

12. B.A. Blonigen and R.B. Wooster, "CEO Turnover and Foreign Market Participation," NBER Working Paper No. 9527, March 2003.

13. J.E. Anderson and E. van Wincoop, "Gravity with Gravitas: A Solution to the Border Puzzle," NBER Working Paper No. 8079, January 2001, and American Economic Review, 93(1), March 2003, pp. 170-92.

14. J.R. Markusen, "Multinationals, Multi-Plant Economies, and the Gains from Trade," Journal of International Economics, 16(3-4): pp. 205-26, and E. Helpman, A Simple Theory of International Trade with Multinational Corporations," Journal of Political Economy, 92(3), pp. 451-71.

15. D.L. Carr, J.R. Markusen, and K.E. Maskus, "Estimating the Knowledge-Capital Model of the Multinational Enterprise," NBER Working Paper No. 6773, October 1998, and American Economic Review, 91(3), June 2001, pp. 693-708, and J.R. Markusen, and K.E. Maskus, "Discriminating Among Alternative Theories of the Multinational Enterprise," NBER Working Paper No. 7164, June 1999, and Review of International Economics, 10(4), November 2002, pp. 694-707.

16. B.A. Blonigen, R.B. Davies, and K. Head, "Estimating the Knowledge-Capital Model of the Multinational Enterprise: Comment," NBER Working Paper No. 6773, October 1998, and American Economic Review, 93(3), June 2003, pp. 980-94.

17. B.A. Blonigen and R.B. Davies, "The Effects of Bilateral Tax Treaties on U.S. FDI Activity," International Tax and Public Finance, 11(5), September 2004, pp. 601-22, and B.A. Blonigen and M. Wang, "Inappropriate Pooling of Wealthy and Poor Countries in Empirical FDI Studies," NBER Working Paper No. 10378, March 2004, and Does Foreign Direct Investment Promote Development? T.H. Moran, E.M. Graham, and M. Blomstrom, eds., Institute for International Economics, April 2005, pp. 221-44.

18. B.A. Blonigen, R.B. Davies, G.R. Waddell, and H.T. Naughton. "FDI in Space: Spatial Autoregressive Relationships in Foreign Direct Investment," NBER Working Paper No. 10939, December 2004, and "Spacey Parents: Spatial Autoregressive Patterns in Inbound FDI," NBER Working Paper No. 11466, July 2005.

"

Paul Krugman: Letter to the Secretary: "Paul Krugman sends a Dear John letter:



Letter to the Secretary, Dear John Snow, by Paul Krugman, NY Times: Dear John Snow, secretary of the Treasury:

I'm glad that you've started talking about income inequality, which in recent years has reached levels not seen since before World War II. But if you want to be credible on the subject, you need to make some changes in your approach.

First, you shouldn't claim, as you seemed to ..., that there's anything meaningful about the decline in some measures of inequality between 2000 and 2003. Every economist realizes that ... 'much of the decline in inequality during that period reflected the popping of the stock market bubble,' which led to a large but temporary fall in the incomes of the richest Americans.

We don't have detailed data ... yet, but the available indicators suggest that after 2003, incomes at the top ... came roaring back. ... I find it helpful to illustrate ... with a hypothetical example: say 10 middle-class guys are sitting in a bar. Then the richest guy leaves, and Bill Gates walks in. Because the richest guy in the bar is now much richer than before, the average income in the bar soars. But the income of the nine men who aren't Bill Gates hasn't increased, and no amount of repeating "But average income is up!" will convince them that they're better off.

Now think about what happened in 2004 ... a small fraction of the population got much, much richer. ... In effect, Bill Gates walked into the bar. Average income rose, but only because of rising incomes at the top.

Speaking of executive compensation, Mr. Snow, it hurts your credibility when you say, as you did ..., that soaring pay for top executives reflects their productivity and that we should "trust the marketplace." Executive pay isn't set in the marketplace; it's set by boards ... And executives' pay often bears little relationship to their performance. You yourself ... are often cited as an example. When you were appointed to your present job, ... the performance of the company you had run, CSX, was "middling at best." Nonetheless, you were "by far the highest-paid chief in the industry." ... So my advice on the question of executive pay is: don't go there.

Finally, you should stop denying that the Bush tax cuts favor the wealthy. ... [U]sing the right measure — the effect of the tax cuts on after-tax income — the bias toward the haves and have-mores is unmistakable. ... once the Bush tax cuts are fully phased in, they will raise the after-tax income of middle-income families by 2.3 percent. But they will raise the after-tax income of people ... with incomes of more than $1 million, by 7.3 percent.

And those calculations don't take into account the indirect effects of tax cuts. If the tax cuts are made permanent, they'll eventually have to be offset by large spending cuts. ... that means cuts where the money is: in Social Security and Medicare benefits. Since middle-income Americans will feel the brunt of these cuts, yet received a relatively small tax break, they'll end up worse off. But the wealthy will be left considerably wealthier.

Of course, my suggestions about how to improve your credibility would force you to stop repeating administration talking points. But you're the secretary of the Treasury. Your job is to make economic policy, not to spout propaganda. Oh, wait."

"

Social Justice and Global Trade: "Joseph Stiglitz discusses trade liberalization and asks how to reform the global trading system to 'enhance the chances that trade and globalization come closer to living up to their potential for enhancing the welfare of everyone.':



Social Justice and Global Trade, FEER, March 2006, By Joseph Stiglitz: The history of recent trade meetings—from Seattle to Doha to Cancun to Hong Kong—shows that something is wrong with the global trading system. Behind the discontent are some facts and theories.

The facts: Current economic arrangements disadvantage the poor. Tariff levels by the advanced industrial countries against the developing countries are four times higher than against the developed countries. The last round of trade negotiations, the Uruguay Round, actually left the poorest countries worse off. While the developing countries were forced to open up their markets and eliminate subsidies, the advanced developed countries continued to subsidize agriculture and kept trade barriers against those products which are central to the economies of the developing world.

Indeed, the tariff structures are designed to make it more difficult for developing countries to move up the value added chain... As tariffs have come down, America has increasingly resorted to the use of non-tariff barriers as the new forms of protectionism. Trade agreements do not eliminate protectionist sentiments or the willingness of governments to attempt to protect producer and worker interests.

The theories: Trade liberalization leads to economic growth, benefiting all. This is the prevalent mantra. Political leaders champion liberalization. Those who oppose it are cast as behind the times, trying to roll back history. Yet the fact that so many seem to have been hurt so much by globalization seems to belie their claims. ...the details of the trade agreements—make a great deal of difference.

That Mexico has done so poorly under NAFTA has not helped the case for liberalization. If there ever was a free trade agreement that should have promoted growth, that was it, for it opened up for Mexico the largest market of the world. But growth in the decade since has been slower than in the decades before 1980, and the poorest in the country, the corn farmers, have been particularly hurt by subsidized American corn.

The fact of the matter is that the economics of trade liberalization are far more complicated than political leaders have portrayed them. There are some circumstances in which trade liberalization brings enormous benefits—when there are good risk markets, when there is full employment, when an economy is mature. But none of these conditions are satisfied in developing countries. With full employment, a worker who loses his job to new imports quickly finds another; and the movement from low-productivity protected sectors to high-productivity export sectors leads to growth and increased wages. But if there is high unemployment, a worker who loses his job may remain unemployed. A move from a low-productivity, protected sector to the unemployment pool does not increase growth, but it does increase poverty. Liberalization can expose countries to enormous risks...

Perhaps most importantly, successful development means going stagnant traditional sectors with low productivity to more modern sectors with faster increases in productivity. But without protection, developing countries cannot compete in the modern sector. They are condemned to remain in the low growth part of the global economy. South Korea understood this. Thirty-five years ago, those who advocated free trade essentially told South Korea to stick with rice farming. But South Korea knew that even if it were successful in improving productivity in rice farming, it would be a poor country. It had to industrialize.

What are we to make of the oft-quoted studies that show that countries that have liberalized more have grown faster? Put aside the numerous statistical problems that plague almost all such “cross country” studies. Most of the studies that claim that liberalization leads to growth do no such thing. ... Studies that focus directly on liberalization—that is, what happens when countries take away trade barriers—present a less convincing picture that liberalization is good for growth.

But we know which countries around the world have grown the fastest: they are the countries of East Asia, and their growth was based on export-driven trade. They did not pursue policies of unfettered liberalization. Indeed, they actively intervened in markets to encourage exports, and only took away trade barriers as their exports grew...

The point is that no country approaches liberalization as an abstract concept... Every country wants to know: For a country with its unemployment rate, with its characteristics, with its financial markets, will liberalization lead to faster growth?

If the economics are nuanced, the politics are simple. Trade negotiations provide a field day for special interests. ... Exporters want others’ markets opened up; those threatened by competition do not. Trade negotiators pay little attention to principles... They pay attention to campaign contributions and votes.

In the most recent trade talks, for example, enormous attention has been focused on developed countries’ protection of their agricultural sectors—protections that exist because of the power of vested agricultural interests there. Such protectionism has become emblematic of the hypocrisy of the West ... Some 25,000 rich American cotton farmers, reliant on government subsidies for cotton, divide among themselves some $3 billion to $4 billion a year, leading to higher production and lower prices. The damage that these subsidies wreak on some 10 million cotton farmers eking out a subsistence living in sub-Saharan Africa is enormous. Yet the U.S. seems willing to put the interests of 25,000 American cotton farmers above that of the global trading system and the well-being of millions in the developing world. If those in the developing world respond with anger, it is understandable.

The anger is increased by the United States’s almost cynical attitude in “marketing” its offers. For instance, at the Hong Kong meeting, U.S. trade officials reportedly offered to eliminate import restrictions on cotton but refused to do anything about subsidies. The cotton subsidies actually allow the United States to export cotton. When a country can export a particular commodity, it does little good to allow imports of that commodity. The U.S., to great fanfare, has made an offer worth essentially zero to the developing countries and berated them for not taking it up on its “generous” offer. ...

In short, trade liberalization should be “asymmetric”, but it needs to be asymmetric in a precisely opposite way to its present configuration. Today, liberalization discriminates against developing countries. It needs to discriminate in their favor. Europe has shown the way by opening up its economy to the poorest countries of the world in an initiative called Everything But Arms. Partly because of complicated regulations (“rules of origin”), however, the amount of increased trade that this policy has led to has been very disappointing thus far. Because agriculture is still highly subsidized and restricted, some call the policy “Everything But Farms.” There is a need for this initiative to be broadened. ... In fact, the advanced industrial countries as a whole would be better off, and special interests in these countries would suffer.

There is, in fact, a broad agenda of trade liberalization (going well beyond agriculture) that would help the developing countries. But trade is too important to be left to trade ministers. If the global trade regime is to reflect common shared values, then negotiations over the terms of that trade regime cannot be left to ministers who, at least in most countries, are more beholden to corporate and special interests than almost any other ministry. In the last round, trade ministers negotiated over the terms of the intellectual property agreement. This is a subject of enormous concern to almost everyone in today’s society. ... It reflected the interests of U.S. drug and entertainment industries, not the most important producers of knowledge, those in academia. And it certainly did not reflect the interests of users, either in the developed or less-developed countries. But the negotiations were conducted in secret, in Geneva. The U.S. Trade Representative (like most other trade ministers) was not an expert in intellectual property; he received his short course from the drug companies, and he quickly learned how to espouse their views. The agreement reflected this one-sided perspective.

Several reforms in the structure of trade talks are likely to lead to better outcomes. The first is that the basic way in which trade talks are approached should be changed. Now they are commercial negotiations. Each country seeks to get the best deal for its firms. This stands in marked contrast to how legislation in all other arenas of public policy is approached. Typically, we ask what our objectives are, and how we can best achieve them. ... If we began trade talks from this position of debate and inquiry, we could arrive at a picture of what a true development round look like. ...

As more and more countries have demanded a voice in trade negotiations, there is often nostalgia for the old system in which four partners (the U.S., EU, Canada and Japan) could hammer out a deal. There are complaints that the current system with so many members is simply unworkable. We have learned how to deal with this problem in other contexts, however, using the principles of representation. We must form a governing council with representatives of various “groups”—a group of the least developed countries, of the agricultural exporting countries, etc. Each representative makes sure that the concerns of his or her constituency are heard. ...

Finally, trade talks need to have more focus. Broadening the agenda also puts developing countries at a particular disadvantage, because they do not have the resources to engage on a broad front of issues.

The most important changes are, however, not institutional changes, but changes in mindset. There should be an effort on the part of each of the countries to think about what kind of international rules and regulations would contribute to a global trading system that would be fair and efficient, and that would promote development.

Fifteen years ago, there was a great deal of optimism about the benefits which globalization and trade would bring to all countries. It has brought enormous benefits to some countries; but not to all. Some have even been made worse off. Development is hard enough. An unfair trade regime makes it even more difficult. Reforming the WTO would not guarantee that we would get a fair and efficient global trade regime, but it would enhance the chances that trade and globalization come closer to living up to their potential for enhancing the welfare of everyone."

Fair Enough?: "When consumers pay extra for Fair Trade certified goods such as coffee, how much of the money goes to the farmers?:



Fair Prices for Farmers: Simple Idea, Complex Reality, by Jennifer Alsever, NY Times: Tim Terman always looks for the black and white certified Fair Trade logo when he buys bags of coffee ... He pays nearly twice as much — up to $10 a pound — as he would for conventional coffee, hoping the extra dollars go to struggling farmers. That's not always the case. ... Critics say too many fair trade dollars wind up in the pockets of retailers and middlemen, including nonprofit organizations.

But organizations involved in fair trade say the benefits do trickle down. Paul Rice, chief executive of TransFair USA, which controls Fair Trade certification in the United States, said the programs sometimes eliminate as many as five middlemen — a local buyer, miller, exporter, shipper and importer — and instead allow farmers to deal directly with an American wholesaler... 'When they do that, they can make dramatically higher prices, often two to three times higher.' ...

Fair trade programs, which promise a "fair wage" to family farmers, have grown rapidly. Today, 35,000 retailers and restaurants nationwide ... carry products bearing the fair trade label, an increase of 60 percent in three years. Since 1999, more than 100 million pounds of certified Fair Trade coffee, cocoa, tea, rice, sugar, bananas, mangoes, pineapples and grapes have been imported... "There are now 800,000 small-scale farmers benefiting from fair trade," said Rick Peyser, director of social advocacy at Green Mountain Coffee Roasters... Still, it can be difficult for consumers to quantify the benefit they bring to farmers ... Fair Trade labels don't list the amount paid to farmers; that ... requires research...

The coffee farmer who produced the one-pound bag of coffee purchased by Mr. Terman received $1.26, higher than the commodity rate of $1.10. But whether Mr. Terman paid $10 or $6 for that fair trade coffee, the farmer gets the same $1.26. "There is no reason why fair trade should cost astronomically more than traditional products," Nicole Chettero, a spokeswoman for TransFair USA, said. "We truly believe that the market will work itself out... As the demand and volume of Fair Trade certified products increase, retailers will naturally start to drop prices to remain competitive." ...

Each fair trade commodity has its own fair trade price, or the lowest price farmers will receive even if conventional commodity prices fall. That price is meant to allow them to cover their cost of production and improve their lives...

In some cases, the individual farmers may receive less than fair trade rules require because the money goes to cooperatives, which have their own directors who decide how much to pass on to farmers. "We did a breakdown and saw that sometimes, what they're paying farmers is only 70 cents to 80 cents a pound" for coffee instead of the entire fair trade price of $1.26, said Christy Thorns, a buyer at Allegro Coffee... Transfair, she said, doesn't "clearly communicate that to consumers."

Allegro is among a number of coffee and tea companies setting up their own systems to work directly with farmers ... Starbucks, which bought 11.5 million pounds of fair trade coffee last year, has created a buying program called CAFE, for Coffee and Farmer Equity Practices... Starbucks requires suppliers to provide receipts showing how each party in the supply chain was paid, but it has no fixed price for the coffee. Starbucks' Web site tells consumers about the program. ...

Without fair trade, supporters say, some farmers have no access to market information and can often be duped into selling to middlemen at below-market prices or, if prices fall, can be forced to quit farming. Ms. Chettero acknowledges the fair trade system is not perfect but said it is a step toward farmers improving their lives. If not for consumers and the fair trade system, she said, "Who else is going to do it?"

"

"The Forces Pushing for Global Wage Equalisation ... are Quite Weak": "Martin Wolf says high income countries should relax, the effect of globalization on the distribution of income is likely to be small. There's no reason to impose protectionist measures which would shift domestic production toward areas where Asia has a comparative advantage:



The answer to Asia’s rise is not to retreat, by Martin Wolf, Financial Times: How can the world’s rich countries compete with the rising Asian powers? ... Soon, it is alleged, the Asian giants will undercut every producer located in rich countries. ... But it is nonsense. The world is indeed suffering a huge supply shock, just as it did prior to the first world war. Then the shock was an increase in the effective supply of land, as the railway and steamship brought the “new world” into the global economy. This time, it is an expansion in the effective labour supply, which has tripled over the past two decades... (see charts).

In an integrated world economy, suggests Helmut Reisen..., equilibrium real wages in high-income countries should fall by about 15 per cent. We do not live in such a world. This is obviously true for labour, where tight controls on migration fragment the global market... average labour costs per hour in Chinese manufacturing were just $0.60 in 2002 against $24 in Germany (see charts). Yet Germany is still the world’s largest exporter of manufactures.

What is the impact of Asia’s entry into a world with such highly segmented pools of labour? ... What ... is the true impact of the labour supply shock? The short answer is that it generates a fall in the world relative prices of labour-intensive goods and services against those more intensive in ... resources of capital (both human and physical) and land. This has two consequences: shifts in the terms of trade, namely, changes in the relative prices of imports and exports ...; and changes in the distribution of income ... as prices of labour, capital and land adjust.

China’s terms of trade have deteriorated markedly since it opened up. Estimates suggest that prices of its exports have fallen by about 25 per cent relative to those of its imports. In this way, China’s exports make the rest of the world better off. That China has made the rest of the world better off, as a whole, does not mean it has made every single country better off. The more similar is a country’s comparative advantage to China’s the more likely it is to be a loser (and vice versa). ... For the high-income countries, Asia’s impact is mixed: it lowers the price of the goods and services they import from developing countries (which makes them better off), but raises the price of imported commodities [such as oil] (which makes them worse off). In recent years, the latter effect has outweighed the former for the US and Germany. The UK has gained, however, largely because it is self-sufficient in energy (see charts)...

For high-income countries, the bigger the gain from falling world prices of labour-intensive imports, the larger the shift in the internal distribution of income against unskilled labour. Thus the benefit also creates the challenge.

Fortunately, it should be a manageable one. The forces pushing for global wage equalisation through trade are quite weak. Nevertheless, the end result is likely to be employment of unskilled labour almost exclusively in the production of non-tradeable goods and services. But provided controls are maintained on immigration of unskilled labour, that need be no disaster. Other measures are also worth considering. Among them are lowering taxes on low-wage incomes; subsidies to the wages of unskilled workers; and support for education and training.

The world is indeed going through a huge supply shock. But for the high-income countries, the best advice is: relax. The internal redistribution of income caused by trade is likely to be modest. Above all, deliberately shifting their structure of production in the direction of Asia’s comparative advantage, through protection, would be mad...

I'm not as confident as he is that the "forces pushing for global wage equalisation through trade are quite weak" and that the "internal redistribution of income caused by trade is likely to be modest." Markets find ways to work and wage differentials such as $.60 versus $24 cannot persist.

Who is Harmed by Polygamy?: "Robert Frank looks at the economics of polygamy:



Polygamy and the Marriage Market: Who Would Have the Upper Hand?, by Robert H. Frank, Economic Scene, NY Times: ...The debut on Sunday night of 'Big Love,' ... about a polygamous fictional family in Salt Lake City, has touched off renewed debate... Barb, Nicki and Margene ... chose to marry Bill Henrickson, a successful businessman... Mr. Henrickson chose to marry them. Should society outlaw such arrangements because they cause unacceptable harm to others? If so, who is harmed, exactly, and how? Economic theory, it turns out, has interesting things to say about these questions.

The traditional argument against plural marriage is that it harms women, particularly younger women who may be coerced to enter such marriages. Needless to say, society should prohibit forced participation ... But mature women who freely choose plural marriage reveal a preference for that arrangement. So if plural marriage harms women, the victims must be those who prefer monogamy.

It is easy to see how some of these women may be harmed. In a monogamous world, ... Barb's first choice might have been to marry Bill, who would also have chosen to marry her. But with plural marriage permissible, Bill might prefer to marry not just Barb, but also Nicki and Margene. Barb then have to choose between two lesser outcomes: a continued search or a plural marriage not to her liking.

Of course, ... that allowing plural marriage may eliminate attractive options for some women does not imply that it imposes unacceptable harm on women generally. Suppose ... that if polygamy were legal, 10 percent of adult men would take an average of three wives apiece and that all remaining marriages would be monogamous. ... The law of supply and demand applies no less to social relationships than to ordinary commercial transactions. With an excess supply of men in the informal market for monogamous marriage partners, the terms of exchange would shift in favor of women. Wives would change fewer diapers, and their parents might even escape paying for weddings.

What about men? Here, too, plural marriage would clearly benefit some. After all, there are surely other men like Bill Henrickson of "Big Love" who would not only prefer multiple wives, but also be able to attract them. But what about those who prefer monogamy? Permitting plural unions would, as noted, create an imbalance of men over women among monogamists. With so many formerly eligible women no longer available, the terms of exchange would turn sharply against men ... Many men would fail to marry at all.

In short, the logic of supply and demand turns the conventional wisdom about plural marriage on its head. If the arrangement harms others, the most likely victims are men, not women.

This conclusion is reinforced if we take account of the costly, and mutually offsetting, jockeying for position associated with ... "positional arms races" ... illustrated by examples from nonhuman animal species. The overwhelming majority of such species are polygynous, meaning that some males take more than one mate. Since having multiple mates is extremely advantageous in Darwinian terms, males typically battle one another ferociously for access to females. Size often decides these battles, so males tend to be considerably larger than females in polygynous species.

Some bull elephant seals, for example, are more than 20 feet long and weigh more than 6,000 pounds ..., whereas females are typically less than 12 feet long and weigh about 1,500 pounds. Natural selection favored larger males because the winners of the long and bloody battles between males often command nearly exclusive sexual access to harems of more than 50 females.

But although being bigger ... is clearly advantageous..., they are also less mobile and hence more vulnerable to sharks and other predators. Relative size, not absolute size, governs the outcomes of fights, so it would clearly be better if each male were only half as large. All fights would be resolved as before, yet all males would be less vulnerable to predators. Unfortunately, however, seals have no practical way of curtailing the arms race that makes them so big.

Permitting plural marriage in human societies would unleash competitive forces analogous to those we see in other species. With women in chronically short supply, men would face even more intense pressure than they do now to get ahead economically, to spend even longer hours honing their abs. More men would undergo cosmetic surgery. Expenditures on engagement rings would rise... Yet no matter how valiantly each man strove, the same number would be destined not to marry.

Unlike other animal species, human societies can employ the power of law to constrain such positional arms races. In addition to whatever other purposes they may serve, laws against plural marriage may function as positional arms control agreements that make life less stressful for men. And this may help explain their appeal to the predominantly male legislatures that enact them."

Do Workers Oppose Immigration Because They Don't Understand Economics?: "Bryan Caplan at EconLog says workers oppose immigration because they don't understand economics, not because of the effect on wages and income:



EconLog: More Cool Work By Hainmueller and Hiscox, by Bryan Caplan: In 'Educated Preferences: Explaining Attitudes Toward Immigration In Europe,' Hainmueller and Hiscox confirm what I've been telling economists for years: Low-skilled workers are more opposed to immigration because they are less economically literate, not because they selfishly calculate that immigration is especially bad for their pocketbooks:



[P]eople with higher levels of education and occupational skills are more likely to favor immigration regardless of the skill attributes of the immigrants in question. Across Europe, higher education and higher skills mean more support for all types of immigrants. These relationships are almost identical among individuals in the labor force (i.e., those competing for jobs) and those not in the labor force.

As a professor, I work in one of the few labor markets that is almost totally open to foreign competition. How often do you think I've heard an American professor grumble that foreign Ph.D.s 'Are taking our jobs!'? Try never. P.S. For more on Hainmueller and Hiscox's work, see here.

The idea that workers will be less opp"

The New York Review of Books: The Health Care Crisis and What to Do About It

The Health Care Crisis and What to Do About It

By Paul Krugman, Robin Wells

Can We Say No? The Challenge of Rationing Health Care

by Henry J. Aaron and William B. Schwartz, with Melissa Cox

Brookings Institution, 199 pp., $44.95; $18.95 (paper)

The Health Care Mess: How We Got into It and What It Will Take to Get Out

by Julius Richmond and Rashi Fein

Harvard University Press, 320 pp., $26.95

Healthy, Wealthy, and Wise: Five Steps to a Better Health Care System

by John F. Cogan, R. Glenn Hubbard, and Daniel P. Kessler

American Enterprise Institute/Hoover Institution, 130 pp., $18.00

Thirteen years ago Bill Clinton became president partly because he promised to do something about rising health care costs. Although Clinton's chances of reforming the US health care system looked quite good at first, the effort soon ran aground. Since then a combination of factors—the unwillingness of other politicians to confront the insurance and other lobbies that so successfully frustrated the Clinton effort, a temporary remission in the growth of health care spending as HMOs briefly managed to limit cost increases, and the general distraction of a nation focused first on the gloriousness of getting rich, then on terrorism—have kept health care off the top of the agenda.

But medical costs are once again rising rapidly, forcing health care back into political prominence. Indeed, the problem of medical costs is so pervasive that it underlies three quite different policy crises. First is the increasingly rapid unraveling of employer- based health insurance. Second is the plight of Medicaid, an increasingly crucial program that is under both fiscal and political attack. Third is the long-term problem of the federal government's solvency, which is, as we'll explain, largely a problem of health care costs....

The Economics of Capital Punishment - Part II: "Here is Gary Becker's response to Posner's comments on capital punishment, also appearing in the Becker-Posner blog and in the latest issue of Economists' Voice:



Becker-Posner blog: More on the Economics of Capital Punishment-Becker: Posner has a good discussion of the various issues... I will concentrate my comments on deterrence, which is really the crucial issue... I support the use of capital punishment for persons convicted of murder because, and only because, I believe it deters murders. If I did not believe that, I would be opposed because revenge and the other possible motives that are mentioned and discussed by Posner, should not be a basis for public policy.



As Posner indicates, serious empirical research on capital punishment began with Isaac Ehrlich's pioneering paper. Subsequent studies have sometimes found much weaker effects than he found, while others, including a recent one cited by Posner, found a much larger effect... The available data are quite limited, however, so one should not base any conclusions solely on the econometric evidence, although I believe that the preponderance of evidence does indicate that capital punishment deters.

Of course, public policy on punishments cannot wait until the evidence is perfect. Even with the limited quantitative evidence available, there are "

The Economics of Capital Punishment - Part I: "This discussion of the economics of capital punishment is from the Becker-Posner blog and appears in the latest issue of Economists' Voice. Richard Posner goes first:



Becker-Posner Blog: The Economics of Capital Punishment--Posner: The recent execution by the State of California of the multiple murderer Stanley 'Tookie' Williams has brought renewed controversy to the practice of capital punishment... From an economic standpoint, the principal considerations in evaluating the issue of retaining capital punishment are the incremental deterrent effect of executing murderers, the rate of false positives (that is, execution of the innocent), the cost of capital punishment relative to life imprisonment without parole (the usual alternative nowadays), the utility that retributivists and the friends and family members of the murderer's victim ... derive from execution, and the disutility that fervent opponents of capital punishment, along with relatives and friends of the defendant, experience. The utility comparison seems a standoff, and I will ignore it...



Early empirical analysis by Isaac Ehrlich found a substantial incremental deterrent effect of capital punishment, a finding that coincides with the common sense of the situation: it is exceedingly rare for a defendant who has a choice to prefer being executed to being imprisoned f"

Measuring Corruption: "The Economist looks at some of the ways economists measure corruption:



Digging for dirt, Economics Focus, The Economist: Corruption ... is not easy to measure. Vast amounts of money flow through public hands. How much is diverted into private pockets? ... Fortunately, a growing number of economists, not least at the bank, are turning to the tricky task of quantifying corruption. ...

Some of the biggest ... were attracted to Iraq's oil-for-food programme, which ran from 1997 to early 2003. Under the scheme's original terms, Iraq sold its oil to whomever it chose... The proceeds ($64 billion in 2000 dollars) were paid into an escrow account and spent largely on food and medicines, under UN supervision. American intelligence officials estimate that Iraq received $230m-240m in bribes from those eager to buy its oil. Economic intelligence, as applied by Chang-Tai Hsieh and Enrico Moretti, of the University of California, Berkeley, suggests that it got far more. As they point out, Iraqi oil, such as Basra Light, is a close substitute for Arabian Light. Before UN sanctions, there was no systematic price difference between the two. But in 1997-98, Basra Light fetched $2 a barrel less; in 2000-01, the gap was more than $5. Bidders would be happy to offer bribes, kickbacks and political favours to secure oil this chea"

Economist.com

As “open-source” models move beyond software into other businesses, their limitations are becoming apparent

EVERY time internet users search on Google, shop at Amazon or trade on eBay, they rely on open-source software—products that are often built by volunteers and cost nothing to use. More than two-thirds of websites are hosted using Apache, an open-source product that trounces commercial rivals. Wikipedia, an online encyclopedia with around 2.6m entries in more than 120 languages, gets more visitors each day than the New York Times's site, yet is created entirely by the public. There is even an open-source initiative to develop drugs to treat diseases in poor countries.

The “open-source” process of creating things is quickly becoming a threat—and an opportunity—to businesses of all kinds. Though the term at first described a model of software development (where the underlying programming code is open to inspection, modification and redistribution), the approach has moved far beyond its origins. From legal research to biotechnology, open-business practices have emerged as a mainstream way for collaboration to happen online. New business models are being built around commercialising open-source wares, by bundling them in other products or services. Though these might not contain any software “source code”, the “open-source” label can now apply more broadly to all sorts of endeavour that amalgamate the contributions of private individuals to create something that, in effect, becomes freely available to all....

Selective Globalization Syndrome: "David Gross tries to start a meme:



David Gross: If the world is flat, capital, goods and services can go wherever they want. But last week, the process of cross-border economic integration suffered the same fate as foolish mortals who would defy Newtonian physics: it crashed to earth. The furious fight over whether several port terminals in the United States should be owned by a company based in Dubai was resolved uncharacteristically and abruptly on Thursday. DP World, owned by the government of the United Arab Emirates, announced it would transfer the American operations of Peninsular & Oriental Steam Navigation, the British company it is in the process of acquiring.

During the port debate, opponents warned darkly of the perils of Arab control of vital industry in the United States, and advocates warned, equally darkly, of the perils of alienating foreign investors. But the maelstrom over maritime services is not the first heated exchange on the way globalization appears to pit national economic interests against national security.

Last summer, anguished protests stopped the Chinese oil company Cnooc from acquiring United States-based Unocal, even though Unocal slakes only a tiny fraction of America's oil thirst. Indeed, the Dubai controversy is merely the latest manifestation of a new condition afflicting politicians, policymakers and o"

‘Tipping Point’ vs. ‘Freakonomics’: "Last Thursday morning, Malcolm Gladwell posted his thoughts on Freakonomics on his new weblog - noting that he endorsed the book, but has some major problems with Chapter 4's argument that rising abortion rates have lead to a fall in the US crime rate:So what gives? Why do I love a book so much, if it contradicts my own book? Have I renounced the theories I put forward in the Tipping Point? I have two answers. The first - obvious..."

Will Economics and Nationalism Collide?: "

Philip Stephens of the Financial Times believes globalization has brought us to a perilous moment: A perilous collision of ideas, by Philip Stephens, Financial Times: Every now and then we are reminded that the onward march of globalisation is not...

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