Development

Inequality and the Instability of Polity and Policy (Economic Journal)

We create alternative measures of political instability, which capture only movements from dictatorship to democracy and vice versa and, unlike older, well known measures does not capture government changes that preserve the democratic or dictatorial structure of the country. We show that inequality is positively correlated with our measures of political instability as well as with a well-known measure (used by Alesina and Perotti), but the impact of inequality on the latter is only through components of political instability captured by our measures. We show that our measures of political instability have significant policy implications – it increases both fiscal and trade polity volatility.

Democracy and Policy Stability (with A. Mushfiq Mobarak)

The strong negative link between democracy and output volatility documented by Rodrik (2000) and others stands in sharp contrast to the lack of consensus on the democracy-growth relationship.  To explain stable growth performance in democracies we characterize political systems in terms of the distribution of political power across groups, and show that in a world where the qualities of available policy alternatives are uncertain, greater democracy (i.e. decentralization of decision-making authority) leads to more stable policy choices. We design an empirical test of this mechanism by creating measures of the inter-temporal variability in fiscal and trade policies for a panel dataset of 92 countries.  In an array of specifications (cross-sectional and panel OLS, fixed effects, random effects, instrumental variables), under 5 different measures of democracy and using sharp episodes of democratizations in a difference in difference, we show that policy choices are significantly more stable over time in democracies.  This mechanism explains a large part of the negative link between democracy and output volatility.

Corruption and Bilateral Trade Flows: Extortion or Evasion (with Daniel Traca) (Review of Economics and Statistics)

This paper analyzes the impact of corruption on bilateral trade flows, highlighting the dual role of corruption in terms of extortion and evasion. On one hand, corruption taxes trade, when corrupt customs officials in the importing country extort bribes from exporters (the extortion effect); on the other, if tariffs are high, corruption may be trade enhancing, when the corrupt officials allow exporters to evade tariff barriers (the evasion effect). The paper derives and estimates a corruption-augmented gravity model that shows that the effect of corruption on trade flows is ambiguous and is contingent on the level of tariffs. The predictions are borne out in the data: corruption taxes trade in the majority of cases, but in high tariff environments (covering 5-14% of the observations,) its marginal effect is trade-enhancing.

Trade Protection and Bureaucratic Corruption: An Empirical Investigation (Canadian Journal of Economics)

This paper examines whether protectionist policies on the part of the government leads to increased corruption on part of the bureaucracy. Using multiple measures of corruption and trade policies, we find strong evidence suggesting that corruption is significantly higher in countries with activist trade policies. The cross-country results are checked for robustness to endogeneity concerns. Next, a panel-data based GMM methodology is used to estimate a dynamic model of corruption. This estimator controls for unobserved country-specific effects, the potential endogeneity of trade policy and other variables, and the existence of measurement errors afflicting the corruption data. The paper strengthens the case for trade liberalization and argues that trade reforms are a means to undertake improvements in governance.

When Corruption Begets Corruption: Welfare Analysis and the Role of Bureaucratic Wages Under Multiple Equilibria R&R at Scottish Journal of Political Economy

The paper presents some empirical puzzles in the relationship between bureaucratic wages and corruption levels, and attempts to reconcile them within a general equilibrium framework that leads to multiple equilibria in the incidence of corruption. In the presence of such multiple equilibria, the relationship between bureaucratic wages and corruption is no longer monotonic, and much more complex than detailed by previous theoretical and empirical research. Further, a welfare analysis shows that social welfare is decreasing in the incidence of corruption, across such equilibria.

Crisis and Consumption Smoothing (with Paddy Padmanabhan) (Marketing Science)

Using historical data on currency crisis episodes across the world, this paper shows that the observed patterns in the impact of a crisis across classes of goods and economies are a consequence of active smoothing of consumption expenditures by consumers. The results reveal that consumer behavior in a crisis is characterized by consumption smoothing at various levels – inter-temporal, inter-category and intra-category. In sum, these behavioral adjustments result in significant reallocation of consumption expenditures. More importantly, the smoothing decisions due to a crisis are distinct and independent of the impact of changes in income and prices that accompany a crisis. Interestingly, there is marked variation in the patterns of consumption smoothing across different types of economies. Taken together, these results have important and interesting implications for managers, policy makers and academics.

Political Economy of Trade Policies

Endogenous Trade Policy through Majority Voting: An Empirical Investigation (Journal of International Economics)

The median-voter approach to trade policy determination (within a Heckscher-Ohlin framework) as in Mayer (1984)  predicts that an increase in inequality, holding constant the economy’s overall relative endowments, raises trade barriers in capital-abundant economies and lowers them in capital-scarce economies. We find support for this prediction using cross-country data on inequality, capital-abundance and diverse measures of protection. We perform certain robustness checks that include controlling for the effects of political rights and schooling as well as using alternative datasets on factor endowments.

Political Ideology and Endogenous Trade Policies: An Empirical Investigation (Review of Economics and Statistics)

In this paper, we empirically investigate how government ideology affects trade policy. The prediction of a partisan, ideology-based model (within a two-sector, two-factor Heckscher-Ohlin framework) is that left-wing governments will adopt more protectionist trade policies in capital-rich countries, but adopt more pro-trade policies in labor-rich economies than right-wing ones. The data strongly support this prediction in a very robust fashion. There is some evidence that this relationship may hold better in democracies than in dictatorships, though the magnitude of the partisan effect seems stronger in dictatorships.

Labor versus Capital in Trade-Policy: The Role of Ideology and Inequality (Journal of International Economics)

Trade policy depends on the extent to which the government wants to redistribute income as well as on a country’s overall factor endowments and their distribution. While the government’s desire to redistribute income itself is dependent on asset distribution, it is to a large extent also driven by the partisan nature of the government, i.e., whether it is pro-labor or pro-capital. Using cross-country data on factor endowments, inequality and government orientation, we find that, conditional on inequality, left-wing (pro-labor) governments will adopt more protectionist trade policies in capital-rich countries, but adopt more pro-trade policies in labor-rich economies than right-wing (pro-capital) ones. Also, holding government orientation constant, higher inequality is associated with higher protection in capital-abundant countries while it is associated with lower protection in labor-abundant countries. These results are consistent with the simultaneous presence of both inequality as well as ideology as determinants of protection within a two-factor, two-sector Heckscher–Ohlin framework. Overall, various statistical tests support an umbrella model (that combines both the ideology and inequality models) over each of the individual models.

Political Economy of Agricultural Distortion Patterns (Project commissioned by the World Bank)

In this paper, we examine the political-economy drivers of the variation in agricultural protection, both across countries and within countries over time. The paper starts by listing the key insights provided by both the theoretical and empirical literature on the political economy of trade policy formulation. We then set out a basic framework that allows us to put forth various testable hypotheses on the variation and evolution of agricultural protection. We find that both the political ideology of the government and the degree of inequality are important determinants of agricultural protection. Thus, both the political-support-function approach as well as the median-voter approach can be used to explain the variation in agricultural protection across countries and within countries over time. The results are consistent with the predictions of a model that assumes that labor is specialized and sector-specific in nature. Some aspects of protection also seem to be consistent with predictions of a lobbying model in that agricultural protection is negatively related to agricultural employment and positively related to agricultural productivity. Public finance aspects of protection also seem to be empirically important.

Trade and Labor Markets

International Trade and Unemployment: Theory and Cross-National Evidence (with Devashish Mitra and Priya Ranjan) Journal of International Economics

In this paper, we present a model of trade and unemployment, in which unemployment is search induced and trade arises as a result of Heckscher-Ohlin (H-O) comparative advantage based on differences in factor proportions and/or Ricardian comparative advantage based on relative technological differences. Using cross-country data on various measures of trade policy, unemployment, and a variety of controls (that include labor-market institutions and macroeconomic distortions), and controlling for endogeneity and measurement error problems, we find fairly strong and robust evidence for the Ricardian prediction that unemployment and trade openness are negatively related (protection and unemployment are positively related). This effect of trade seems to dominate the H-O effect of trade openness on unemployment that changes from negative to positive as we move from labor-abundant to capital-abundant countries. Using panel data, we find support for an unemployment increasing short-run impact effect of trade liberalization, followed by an unemployment reducing effect leading to the new steady state.

With Whom Do You Trade? Defensive Innovation and the Skill-bias(with Daniel Traca) Canadian Journal of Economics

We examine whether increased trade with countries with weak or ineffective protection of intellectual property has contributed to the skill deepening of the 1980s. We draw on Thoenig and Verdier’s (2003) theory that the threat of competitive imitation from countries where the protection of intellectual property rights (IPR) is low promotes skill-biased strategies and technologies, which are less likely to be imitated. We first construct an index of effective protection of intellectual property at the country level, combining data on the statutory protection of patents and the rule of law (as a proxy for enforcement). Next we construct an industry-specific version of this index, using as weights each country's trade share in the total trade of the industry. We find an important and pervasive decline in this trade weighted index, due to a rise in trade with countries with a low effective protection of intellectual property, which explains 29% of the rise in within-industry skill intensity.

Labor Market Outcomes and Trade Reforms: The Case of India (book chapter)

This paper takes examines linkages between international trade and labor markets in India. The Hecksher-Ohlin theory predicts that with greater openness to international trade, India’s labor-intensive manufactures and exports should expand and the abundant factor (unskilled labor) should benefit from the movement towards free trade. I examine whether there is support for such a prediction in the context of the trade liberalization undertaken since 1991.

Structure of Trade and Production

Does WTO Matter for the Extensive and the Intensive Margin of Trade? (with Ilian Mihov and Timothy Van-Zandt)

We use 6-digit bilateral trade data to document the effect of WTO/GATT membership on the extensive and intensive margins of trade.We construct gravity equations for the two product margins where the specifications of these gravity equations are motivated by the model of Eaton and Kortum (2002). The data show that the puzzle of no significant impact of WTO membership on trade documented by Rose (2004) manifests itself differently at the product margins of trade. We show that the impact of the WTO is almost exclusively on the extensive product margin of trade, i.e. trade in goods that were not previously traded. In our preferred specification WTO membership increases the extensive margin of exports by 31%. At the same time, WTO membership has a negligible or even a negative impact on the intensive margin (the volume of already-traded goods). Incidentally, we also document that standard gravity variables provide good explanatory power for bilateral trade on both margins.

Export Diversification and Economic Development (with Ilian Mihov and Timothy Van-Zandt)

In this paper, we document patterns of export diversification, its evolution over time, the drivers of export diversification, and its consequences for economic development. First, we show that trade costs---measured in terms of distance to trading centers and market access through a host of trading arrangement (multilateral, bilateral and unilateral)---are key drivers of diversification. Second, we provide evidence for a causal link from export diversification to development and show that an increase in the extensive margin of exports is much more effective in raising per capita income than increasing the intensive margin of exports. Third, we show that what is most effective for economic development is broadly mimicking the production structure of the US, especially in those industries where the US is the most productive.

Stock Market Comovements and Industrial Structure (with Ilian Mihov) R&R Journal of Money Credit and Banking

We use monthly stock market indices for 58 countries to construct pairwise correlations of returns and explain these correlations with differences in the industrial structure across these countries. We find that countries with similar industries have stock markets that exhibit high correlation of returns. The results are robust to the inclusion of other regressors like differences in income per capita, stock market capitalizations, measures of institutions, as well as various fixed time, country and country-pair effects. We also find that differences in the structure of exports explain stock market correlations quite well. Our results are consistent with models in which the impact of each industry-specific shock is proportional to the share of this industry in the overall industrial output of the country. We also show that differences in production structures have higher explanatory power for segmented markets rather than for markets that are integrated.