Unequal Gains, Prolonged Pain A Model of Protectionist Overshooting and Escalation Emily J. Blanchard Gerald Willmann Tuck at Dartmouth & CEPR U. Bielefeld & IFW Kiel April 2019
Brexit, Trump, Le Pen, AfD, Conte, Bolsanaro, AMLO...
Brexit, Trump, Le Pen, AfD, Conte, Bolsanaro, AMLO... What’s driving this surge in economic nationalism? Is this a temporary shift or the new normal? Will domestic policy interventions dampen support for protectionism? How about international agreements and rules? We build a model of short-run and long-run drivers of economic nationalism, then use the model as a guide to read the tea leaves.
Motivating Observation Adjustment Costs Matter... Especially in Politics Structural change is slow and costly – abundant evidence that workers face large and long-lasting adjustment costs: e.g. Artuc, Chaudhuri, McLaren (AER ‘10); Autor, Dorn, Hanson (AER ‘13+); Dix-Caniero (Econometrica ‘14), etc. Political change is potentially much faster. Unanticipated shocks + sticky economic adjustment → even potential “winners” from change can be losers in the short run → political pushback
Economic Stickiness Shapes Political Outcomes A crucial distinction: Winners and losers in the long run: • Well understood (e.g. Mayer 1984): long run political outcome depends on distribution of gains. • Even in the long run equilibrium, policy and economic decisions are endogenous and interdependent. Winners and losers in the short run: • Dynamics are key; we need to take time – and the potential for differences in economic vs. political frictions – seriously. ⇒ Most political economy models are static, steady state, or “rigged” to ensure smooth transitions between steady states, and so miss key features of dynamic adjustment.
Overview of Approach This paper: 1 Develops a dynamic political economy model where policy can adjust quickly, but economic adjustment takes longer. 2 Characterizes a salient political environment: • Labor market adjustment to global price shocks and SBTC; • Endogenous policy tool is a tariff – highlights tradeoff between aggregate efficiency and redistribution. 3 Demonstrates the potential for Protectionist Overshooting and Protectionist Escalation in response to shocks. 4 Considers ameliorating potential (or not) of redistribution and education policy interventions. 5 Examines key data markers suggested by theory.
Preview of Results Implications of the Theory 1 Unequal Gains ⇒ Prolonged Pain: • If returns to openness are skewed toward the top, ↓ world price of low skill goods ⇒ Protectionist Surge. • Magnitude and longevity ↑ w. initial inequality 2 Long run outcome hinges on whether rising skill premium and education increases or decreases inequality. • Convergence ⇒ Overshooting; Divergence ⇒ Escalation 3 Along the way: • SBTC and TOT are shocks essentially isomorphic. • ‘Complex redistribution’ necessary to defuse protectionism, but blunts incentives ⇒ fundamental tension. • Education policy removes tension, but risks divergence. • Safeguards are essential under overshooting. 4 Key data markers: mean vs. median gap; stickiness • U.S./U.K. data suggestively different
Remainder of Talk Related Literature Model • Case 1: Protectionist Overshooting • Case 2: Protectionist Escalation Bonus implications: SBTC, redistribution, safeguards Empirical implications & informative data markers Conclusion
Related Literature Trade and Labor Adjustment Matsuyama (1992); Davidson and Matusz (2008); Artuc, Chaudhuri, McLaren (2010); Davis and Harrigan (2011); Autor, Dorn, Hanson (et al) (2013 +); Dix-Caniero (2014); Krishna, Poole, Senses (2014), etc Endogenous Tariffs & Dynamic Trade Policy Mayer (1984); Staiger and Tabellini (1987); Fernandez and Rodrik (1991); Brainard and Verdier (1997); Dutt and Mitra (2002); Mayda and Rodrik (2005); Blanchard and Willmann (2011); many others Economic-Political Feedback; Democracy, Inequality, and SBTC e.g. Acemo˘ glu and Robinson (2013); Hassler, Rodr´ ıguez-Mora, Storesletten, & Zilibotti (2003); Acemo˘ glu, Gancia, and Zilibotti (2012); Acemo˘ glu, Naidu, Restrepo, Robinson (2013); Alesinia and Rodrik (1994); Persson and Tabellini (1994), etc.
Modeling Populist Surges: Brexit/Trump Dynamics? Heterogeneous OLG workers make lifelong (“putty-clay”) decisions over their own education, vote on policy. If expectations are correct, individual human capital investments, voting are ex-post optimal ⇒ steady state. Add an unanticipated global shock: e.g. a “China Shock” (TOT) – or SBTC – that exacerbates existing inequality. Skills are stuck, at least for a while, but policy can change. If politically pivotal median voter is less skilled than ‘average’ ⇒ Protectionist Surge
Sketch of the Model Individuals and Education Continuum of heterogenous agents live for 2 periods Agents born with innate advantage, a ∈ [0 , 1] When young, choose optimal educational investment, e . Cost of education is foregone wages as a young unskilled worker. Time constraint: l + e = 1 In second stage of life, education and advantage → human capital, h ≡ h ( a, e ) s.t.: h a > 0 h e > 0 h ee < 0 h ae > 0
Sketch of Model, cont. Production and Trade SOE with two goods: U , basic numeraire and S , skill-based U : one-for-one in unskilled labor → unskilled wage =1 S : x ( h ) ≡ bh where b > 0 ( ↑ b ≈ SBTC) Assume our economy has comparative advantage in S Total return to human capital: xp = bhp , where p ≡ p w τ ⇒ Trade liberalization increases returns to education Preferences Identical, homothetic, additively separable across time: u ( d y u , d y s ) + βu ( d o u , d o s ) where β > 0 and u ( d u , d s ) ≡ d (1 − α ) d α u s
Educational Investment Optimal educational attainment maximizes lifetime indirect utility. For the young voter at time t : V ( p t , I y t ( e, p t )) + βV ( p t +1 , I o max t +1 ( h ( a, e ) , p t +1 ) e where V ( p, I ) ≡ v ( p ) I . ⇒ Optimal education level, e ( a ; τ t , τ t +1 ) is • increasing in initial advantage (single crossing) • increasing in current & future domestic price of S ◮ decreasing in current and future tariff, all else equal
Politics Median Voter Model (easily relaxed) Majority voting. Median voter is decisive. Only the old vote. Individual tariff preference depends on a and education Individually optimal tariff given by the FOC: � � d ¯ E o,s ∂p t [ E o,s t ( a ) − ¯ E o,s V o t τ ( a ) = v I t ] + t t p t = 0 . (1) ∂τ t dτ t � �� � ���� � �� � ≡ ∆ t ( a ; e t − 1 ) ( − ) = 0 @ t=0 � �� � � �� � std optimal tariff individual bias Lower (higher) advantage/education ⇔ ∆( a ) < 0 (∆( a ) > 0)
Politics Equilibrium Trade Policy, τ t = τ ( a M ; e t − 1 ) Determined by education of median voter born in previous generation; Decreasing in ∆ m t ≡ ∆( a M , e t − 1 ); i.e. the median voter’s human capital relative to the mean in her generation. Individually Optimal Tariff Derivation
Solving the Model Solution Strategy 1 Define political equilibrium using median voter rule and rational expectations. 2 Steady state defined by τ ( e M ; e t − 1 ), e M ( τ ). 3 Adopt ‘nice’ case conditions: unique, interior steady state 4 Shock the economy with a TOT improvement [or SBTC]; study dynamics
Political Equilibrium Definition A rational expectations political equilibrium is defined by a sequence of tariff and education rule pairs, ( τ t , e t ( a )) t ∈ N such that the following hold for all t ∈ N : 1 τ t maximizes indirect utility of the median voter given the previous period’s education schedule, e t − 1 ( a ); 2 e t ( a ) ≡ e ( a ; τ t , τ t +1 ) is optimal for every agent given rational expectations of current and future tariff levels.
Political Steady State Definition Political Steady State. A political steady state is reached when τ t ≡ T ( e M t − 1 , e t − 1 )) = ˜ τ ; ∀ t . A political steady state can be summarized by the steady state education level of the median e M , ˜ voter and concomitant policy outcome pair, { ˜ τ } , where: � � τ ˜ τ ) = h − 1 e ( a ) ˜ = e ( a, ˜ a, ∀ a e βbp w e M , e t − 1 ) = arg max V o ( τ ; a M , ˜ e M , e t − 1 ) . ˜ τ = T (˜ τ
Unique Stable Steady State
Permanent Terms of Trade Shock Our thought experiment Consider a permanent TOT improvement ( p w ↑ ) [or b ↑ ]. For any given tariff level, the incentive to acquire education would rise, but in the short run, the median voter will become more protectionist iff her net export position is below ‘average’. Characterize transition dynamics and new steady state
Steady state response to ↑ p w
Steady state response to ↑ p w e ( τ ) shifts right/up
Steady state response to ↑ p w τ ( e M ) shifts up iff median voter relatively less skilled ( ˜ ∆( a M ) < 0)
Steady state response to ↑ p w Net effect ambiguous – first, we depict case in which ˜ e ↑ and ˜ τ ↓
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