NBER Reporter: Summer 2001

International Trade and Investment

The NBER's Program on International Trade and Investment met in Cambridge on March 16 and 17. James Harrigan, Federal Reserve Bank of New York, organized this program:

Robert Feenstra, NBER and University of California, Davis, and Gordon Hanson, NBER and University of Michigan, "Global Production and Rising Inequality: A Survey of Trade and Wages"

James Harrigan, "Comparative Advantage: Do the Data Obey the Law?"

Donald Davis and David E. Weinstein, NBER and Columbia University, "The Factor Content of Trade"

Robert E. Lipsey, NBER and Queen's College, "Foreign Direct Investment and the Operations of Multinational Firms"

James Markusen, NBER and University of Colorado, and Keith E. Maskus, University of Colorado, "Multinationals"

Henry Overman, Stephen Redding, and Anthony J. Venables, London School of Economics, "Trade and Geography: A Survey of Empirics"

James R. Tybout, NBER and Pennsylvania State University, "Plant and Firm-Level

Evidence on 'New' Trade Theories"

Bruce Blonigen, University of Oregon, and Thomas Prusa, NBER and Rutgers University, "Antidumping"

Kishore Gawande, University of New Mexico, and Pravin Krishna, Brown University, "The Political Economy of Trade Policy"

Feenstra and Hanson argue that trade in intermediate inputs, or "outsourcing," is a potentially important explanation for the increase in the wage gap between skilled and unskilled workers in the United States and elsewhere. They show that trade in inputs has much the same impact on labor demand as does skill-biased technical change: both will shift demand away from low-skilled activities, while raising relative demand and wages of the higher skilled. Thus, distinguishing whether the change in wages is caused by international trade or technological change is fundamentally an empirical rather than a theoretical question. The authors review three empirical methods that have been used to estimate the effects of the outsourcing and technological change on wages, and summarize the evidence for the United States and other countries.

The theory of comparative advantage predicts that countries export goods that would have lower relative prices in the absence of trade. Harrigan reviews recent empirical research on this prediction. Much of this work focuses on output specialization rather than trade, arguing that most of the interest in the comparative advantage theory comes from the production side alone. Starting with the multidimensional generalization of the standard Heckscher-Ohlin model, authors have considered amendments that include unequal numbers of goods and factors, Ricardian technological differences, and multiple patterns of specialization. All of these refinements matter in explaining the sources of comparative advantage, and Harrgian concludes that considerable progress has been made in understanding the causes of specialization.

Davis and Weinstein examine the literature on the factor content of trade. They argue that understanding the factor content of trade is critical to understanding whether our models of general equilibrium "hang together." The last fifteen years have seen wide swings in trade economists' views of models of the factor content of trade. The authors do not want to suggest that all issues about the factor content of trade are settled; future work needs to gather better and more extensive datasets, to more carefully consider the role of traded intermediates, cross-country differences in demand, the role of trade costs, and so on. But the progress made in the last fifteen years surely holds promise that this will continue to be a fertile area for research, they conclude.

Lipsey reviews the changes that have taken place in the concept and measurement of foreign direct investment (FDI) and the differences between what is measured in balance-of-payments stocks and flows of FDI and what is implied by theories of FDI motivations and activities. Measured stocks of FDI are fairly well correlated with the activity of multinationals across countries, but hardly related at all to the distribution of activity among industries or among industries and countries. Thus, stocks of FDI give a misleading picture of what multinationals are doing in their host countries. Early studies for the United States, Sweden, and the United Kingdom all conclude that there was either no relationship between overseas production and parent firm or home country exports or a positive relationship. In recent years there have been similar studies of the effects of overseas production for Japan and several European countries, with basically the same conclusions. Similarly, there seems to be little relation between overseas production and parent or home country aggregate employment. In U.S. counties, greater foreign production is associated with lower home employment per unit of output, or lower labor intensity in home production, but in Swedish and Japanese firms, higher overseas production means more labor per unit of output at home. Within their host countries, the affiliates of foreign firms sometimes introduced entirely new industries and new bases for comparative advantage in exports. Affiliates almost universally appear to pay higher wages than the corresponding host country firms and have higher productivity levels. They also pay higher wages than domestically-owned firms of the same size and other characteristics. In the few cases where characteristics of workers can be examined, foreign-owned firms pay higher wages for what appear to be equivalent workers, a higher price for labor than domestic firms.

Beginning in the early 1980s, theoretical analyses incorporated the multinational firm into the microeconomic, general-equilibrium theory of international trade. Recent advances indicate how vertical and horizontal multinationals arise endogenously as determined by country characteristics, including relative size and relative endowment differences, and trade and investment costs. Results also characterize the relationship between foreign affiliate production and international trade in good and services. Markusen and Maskus survey some of this recent work, and note the testable predictions generated in the theory. They go on to examine empirical results that relate foreign affiliate production to country characteristics and trade/investment cost factors. Finally, they review findings from analyses of the pattern of substitutability or complementarity between trade and foreign production.

Overman, Redding and Venables survey the empirical literature relating trade flows, factor prices, and the international location of production to economic geography. First they present a general theoretical model which incorporates key mechanisms from theoretical research on new economic geography while remaining sufficiently general to provide the basis for empirical work. In the presence of transport costs and with intermediate inputs in production, access to markets and suppliers are important determinants of firm profitability. In general equilibrium, production location decisions will be determined by a combination of the considerations emphasized by traditional trade theory (factor endowments and exogenous technology differences) together with market and supplier access. The remainder of the survey is structured around the model's implications for international trade, the variation in factor prices across geographic space, and production structure. Increased distance raises trade costs with an elasticity between 0.2 and 0.3 and reduces trade volumes with an elasticity between -0.9 and -1.5. Access to markets and sources of supply plays a statistically significant and quantitatively important role in explaining variation in factor prices within and between countries. Access to foreign markets alone explains some 35 percent of the cross-country variation in per capita income. There is a positive relationship between market access and wages across U.S. counties which is robust to controlling for unobserved heterogeneity, human capital, demography, and exogenous amenities. Models of imperfect competition and increasing returns to scale imply a home market or magnification effect, whereby increases in expenditure on a good lead to a more than proportionate increase in production. Home market effects arise in a number of key manufacturing sectors.

By relaxing the assumption of perfect competition, the "new" trade theory has generated a rich body of predictions concerning the effects of commercial policy on price-cost mark-ups, firm sizes, exports, productivity, and profitability among domestic producers. Tybout critically assesses the plant-and firm-level evidence on these linkages. He finds first that mark-ups generally fall with import competition, but it is not clear whether this reflects the elimination of market power or the creation of negative economic profits. Second, import-competing firms cut back their production levels when foreign competition intensifies, at least in the short run. This suggests that sunk entry or exit costs are important in most sectors. Third, trade rationalizes production in the sense that markets for the most efficient plants are expanded, but large import-competing firms tend simultaneously to contract. Fourth, exposure to foreign competition often improves intra-plant efficiency. Fifth, firms that engage in international activities tend to be larger, more productive, and supply higher quality products. However, the literature is mixed on whether the activities caused these characteristics or vice versa. Finally, the short-run and long-run effects of commercial policy on exports and market structure can be quite different. Both types of response depend upon initial conditions, sunk entry costs, and the extent of firm heterogeneity.

Blonigen and Prusa review the growing literature on the effects of antidumping (AD), a trade policy that has emerged as the most serious impediment to international trade. They show that AD was a rarely used trade law until the mid-1970s. Over the past 25 years countries have increasingly turned to AD in order to offer protection to import-competing industries. Antidumping is a trade policy where the filing decision, the legal determination, and the protective impact are all endogenous. AD can facilitate collusion and can distort market prices even if cases are never filed. Also, the trade impact of macroeconomic shocks, such as exchange rate movements and GNP fluctuations, is complicated by the presence of AD law. The authors discuss the factors that appear to be most important for the determination of injury and also what influences whether domestic and foreign parties participate in the AD investigation process. Finally they assess the market effect of AD protection. AD duties affect both the trade from subject countries and the imports from non-subject countries. Antidumping duties also encourage foreign firms to invest in protected domestic markets. Blonigen and Prusa discuss how the assessment of AD duties complicates the pas-through behavior of sanctioned firms.

Despite a relative consensus on the merits of free trade, trade between nations has never been free. In recent decades, an impressive literature has attempted to answer the question of why this is so. The primary explanation that has been offered is that trade policies are not set by those who seek to maximize economic efficiency; rather, they are set in political contexts where the private incentives of the policymakers differ from aggregate welfare maximization. This study of "endogenous" trade policy determination, which explicitly accounts for the political circumstances under which policy is set, forms the core of the so-called "political economy" of trade literature. Gawande and Krishna attempt to survey its empirical ambitions and accomplishments to date. The early literature mostly involved the examination of correlations between trade policies and various political and economic factors that had been conjectured to be relevant in determining trade policy. This literature often was criticized for employing econometric specifications whose link with the theory that motivated them was tenuous. Later, the empirical literature moved in a somewhat "structural" direction, establishing a much tighter link with the theory than has been traditional in this field. The authors discuss and contrast the early empirical work in this area with more recent approaches, focusing on the unresolved issues and puzzles highlighted in the recent work.

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