Working Papers
Looking Backward, Innovating Forward: A Theory of Competitive Cascades
With Kevin Lim & Miaojie Yu. Revise and resubmit, Journal of International Economics.
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Innovation depends on exporting and on scale and competition in export markets. We develop a theory featuring quality-segmented markets, step-by-step innovation along a quality ladder, and escape-the-competition motives for innovation. We derive four predictions about the impact of scale and competition on innovation: a firm with a large and less-competitive quality segment forward of it will have strong incentives to innovate into this profitable segment, while a firm with a small and more-competitive quality segment behind it will have strong incentives to innovate for fear of facing firms in this segment. We take these predictions to Chinese firmlevel data during a period of explosive export growth. Using information about scale and competition by quality segment in China’s export markets, we confirm all four hypotheses. Unlike in standard CES models, the impact of trade on innovation depends critically on how it drives scale and competition in high- versus low-quality segments.
On the Negative Consequences of Low-Wage Offshoring for Innovation
With Wulong Gu & Alla Lileeva. NBER Working Paper #35167.
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Conventional wisdom holds that offshoring intermediates to China stimulates innovation. This is not entirely compelling. On the one hand, (a) offshoring lowers marginal costs and expands sales, thereby increasing the returns to innovation, especially for large firms. On the other hand, (b) offshoring low-quality intermediates reduces the costs of older-generation products, thereby reducing the returns to innovating into newer generations. We examine these two opposing forces over 2002–2011 for 6,024 Canadian firms. Our empirical strategy regresses measures of innovation, such as R&D, on imports of intermediate inputs. (Intermediate inputs are identified at the firm level using firm-HS6-level data on imports and outputs.) To address endogeneity, we construct a model-consistent shift-share instrument whose shocks are the often-dramatic improvements in the quality of HS6 Chinese intermediate inputs. We find that greater offshoring reduced R&D spending over 2002–2011 by 15% as (1) firms engaged in R&D in 2002 reduced their expenditures, and (2) firms not initially engaged in R&D were discouraged from starting up new R&D projects. Our model explains these findings: Rising quality of Chinese intermediates is a positive supply shock (rather than a negative China shock) that raises profits for all offshorers, raises innovation for the largest offshorers (channel a above), and lowers innovation for all other offshorers (channel b). These predictions are confirmed in the data.
Knowledge Creation and Control in Organizations
With Diego Puga. NBER Working Paper #9121.
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The incremental innovations that underly much of modern economic growth typically involve changes to one or more components of a complex product. This creates a tension. On the one hand, a principal would like an agent to contribute innovative components. On the other hand, ironing out incompatibilities between interdependent components can be a drain on the principal's energies. The principal can conserve her energies by tightly controlling the innovation process, but this may inadvertently stifle the agent's incentive to innovate. We show precisely how this tension between creating knowledge and controlling knowledge shapes organizational forms. The novel concepts introduced are illustrated with case studies of the flat panel cathode ray tube industry and Boeing's recent location decisions.
Writings on AI (academic and public)
Confronting Global Limits of AI
In I.-H. Cheng and A. Goldfarb (eds.). In the AI Era, Management Matters More, Not Less, 2026.
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When AI makes intelligence abundant, judgment becomes the competitive advantage.
Artificial intelligence can generate predictions, analyze information and reason through increasingly complex problems. But it can’t decide what matters, weigh competing priorities, navigate uncertainty or take responsibility for the consequences.
This collection of articles from Rotman faculty members explores the essential role of managerial judgment in an AI-enabled world. As AI becomes more capable and widely available, the responsibilities of management do not disappear. They become more important — and more valuable — than ever.
The impact of AI and cross-border data regulation on international trade in digital services
With Ruiqi Sun. Journal of International Economics. 2026.
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International trade in digital services, including mobile app trade (e.g., Facebook in Frankfurt, Instagram in Istanbul), is large and rapidly growing. Analysing 2015–2020 data on 28,000 mobile apps, we find that AI increases an app’s user base threefold, a massive effect. AI’s handmaiden is data, including cross-border flows of personal data. Concerned with privacy and national security, policymakers have responded with thousands of conflicting data regulations, ranging from guaranteeing free trade in data (USMCA) to data export bans. We are the first to show that these regulations matter: AI’s massive effect is halved in countries with strict data flow restrictions.
An Economic Case for Regulating Artificial Intelligence and Implications for Policy
Canadian Public Policy. January, 2026.
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This article examines how scalable technologies affect the economy, politics, and civil society. Historically, these technologies have triggered a cascading effect: dominant firms earn massive profits, leverage that economic power to influence laws that favour incumbents, and ultimately drive social inequality and erode social cohesion. Artificial intelligence (AI) follows this pattern but adds first-order impacts by directly reshaping political conduct and civil discourse. I propose a regulatory framework focused on when and how to intervene. AI regulation should be non-existent or minimal at the development stage, triggered only when economic scale increases and negative externalities are generated. Major regulatory requirements such as interoperability and data portability would likely be reserved for very large AI systems. This light-touch approach—focused on monitoring scale and exposure—mirrors macro-prudential banking regulation. It offers a middle ground between the European Union's AI Act (which may act prematurely and discourage innovation) and US competition policy (which typically acts too slowly). Finally, I argue that because externalities manifest at the point of user engagement, regulation should target applications rather than underlying models. It must also adjust to the reality of limited Canadian control over AI platforms in other countries.
Building Global Chains of Trust
In Trading with Intelligence: How AI Shapes and is Shaped by International Trade, World Trade Organization, 2024.
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During the Industrial Revolution, living standards in a small group of economies broke free of past growth trends. Driven on by innovations that systematically mobilized science, incomes and public health rapidly improved. It was the epoch of the “invention of innovation”.
That epoch is about to be repeated: AI represents a major re-invention of innovation, positioning humanity to revolutionize fields such as healthcare, agriculture and material efficiency. However, AI also introduces unprecedented levels of distrust in the goods and services it creates and powers. Addressing this distrust is where the WTO can play a crucial role, by developing and enforcing international AI regulations.
AI, Trade, and Creative Destruction: A First Look
With Ruiqi Sun. Robots and AI: A New Economic Era. January, 2022.
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Robots and artificial intelligence (AI) are powerful forces that will likely have large impacts on the size, direction, and composition of international trade flows. This book discusses how industrial robots, automation, and AI affect international growth, trade, productivity, employment, wages, and welfare. The book explains new approaches on how robots and artificial intelligence affect the world economy by presenting detailed theoretical framework and country-specific as well as firm-product level-specific exercises. This book will be a useful reference for those researching on robots, automation, AI and their economic impacts on trade, industry, and employment.
What Is Artificial Intelligence Bringing to International Trade?
Hinrich Foundation website, 2022
How Artificial Intelligence Impacts International Trade
With Avi Goldfarb. In The World Trade Report 2018 edited by the World Trade Organization, 2019.
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Artificial intelligence (AI) is an emerging new general-purpose technology that promises to increase productivity and improve well-being. Within a generation, it will transform some of the largest categories of international trade in goods (e.g., autonomous vehicles) and international trade in services (e.g., financial services). Remarkably, AI technologies have already diffused to China, which is set to become an AI world leader in less than a generation. This is a development that has the potential to reconfigure world trade patterns. Whether this potential is realized is an open question largely because regulatory frameworks surrounding AI will be major determinants of how AI-based products are traded. This is already apparent. Some of the largest US firms by market capitalization (Google, Facebook and Amazon) do not have access to the Chinese market due to regulation. Likewise, some of the largest Chinese firms by market capitalization (Tencent and Alibaba) may be excluded from the US market on the basis of national security concerns.
AI and Trade
With Avi Goldfarb. In The Economics of Artificial Intelligence edited by Ajay Agrawal, Josh Gans and Avi Goldfarb, NBER and University of Chicago Press, 2019.
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The last two hundred years have produced a remarkable list of major innovations, not least of which is artificial intelligence (AI). Like other major innovations, AI will likely raise average incomes and improve well-being, but it may also disrupt labor markets, raise inequality, and drive non-inclusive growth. Yet, even to the extent that progress has been made in understanding the impact of AI, we remain largely uninformed about its international dimensions. This is to our great loss. A number of countries are currently negotiating international agreements that will constrain the ability of sovereign governments to regulate AI, such as NAFTA and TPP-11. Likewise, governments around the world are freely spending public funds on new AI clusters designed to shift international comparative advantage towards their favored regions, including the Vector Institute in Toronto and the Tsinghua-Baidu deep learning lab around Beijing. The international dimensions of AI innovations and policies have not always been well thought out: This work begins the conversation.
International Trade: Select Journal Publications
Trade Liberalization and the Theory of Endogenous Protection: An Econometric Study of U.S. Import Policy
Journal of Political Economy. February 1993.
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Trade theorists continue to puzzle over their surprisingly small estimates of the impact of trade liberalization on imports. All explanations of the puzzle treat trade liberalization as a given. But the level of trade protection is not exogenous. The theory of endogenous protection predicts that higher levels of import penetration will lead to greater protection. This paper finds that when trade protection is modeled endogenously, its restrictive impact on imports is large, 10 times the size obtained from treating protection exogenously.
International Factor Price Differences: Leontief was Right!
Journal of Political Economy. December 1993.
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The factor price equalization hypothesis is widely at odds with the large variation in factor prices across countries. Similarly, the Heckscher-Ohlin-Vanek (HOV) theorem constitutes an incomplete description of trade in factor services: its predictions are always rejected empirically. These two issues are examined using a modification of the HOV model that allows for factor-augmenting international productivity differences. The empirical results are stark: this simple modification of the HOV theorem explains much of the factor content of trade and the cross-country variation in factor prices.
The Case of the Missing Trade and Other Mysteries
The American Economic Review. December 1995.
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The Heckscher-Ohlin-Vanek (HOV) theorem, which predicts that countries will export products that are made from factors in great supply, performs poorly. However, deviations from HOV follow pronounced patterns. Trade is missing relative to its HOV prediction. Also, rich countries appear scarce in most factors and poor countries appear abundant in all factors, a fact that squares poorly with the HOV prediction that abundant factors are exported. As suggested by the patterns, HOV is rejected empirically in favor of a modification that allows for home bias in consumption and international technology differences.
Increasing Returns to Scale and All That: A View From Trade
American Economic Review. September 2002.
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Do scale economies help to explain international trade flows? Using a large database on output, trade flows, and factor endowments, we find that allowing for the presence of increasing returns to scale in production significantly increases our ability to predict international trade flows. In particular, using trade data, we find that a third of al goods-producing industries are characterized by increasing returns ot scale. Thus, scale economies are a quantifiable and important source of comparative advantage.
The Long and Short of the Canada-U.S. Free Trade Agreement
American Economic Review. September 2004.
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The Canada-U. S. Free Trade Agreement provides a unique window onto the effects of a reciprocal trade agreement on an industrialized economy (Canada). For industries that experienced the deepest Canadian tariff cuts, the contraction of low-productivity plants reduced employment by 12 percent while raising industrylevel labor productivity by 15 percent. For industries that experienced the largest U. S. tariff cuts, plant-level labor productivity soared by 14 percent. These results highlight the conflict between those who bore the short-run adjustment costs (displaced workers and struggling plants) and those who are garnering the long-run gains (consumers and efficient plants).
Sorting It Out: International Trade with Heterogeneous Workers
With Franziska Ohnsorge. Journal of Political Economy. October 2007.
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Each worker brings a bundle of skills to the workplace, for example, quantitative and communication skills. Since employers must take this bundle as a package deal, they choose workers with just the right mix of skills. We show that international differences in the distribution of worker skill bundles—for example, Japan’s abundance of workers with a modest mix of both quantitative and teamwork skills—have important implications for international trade, industrial structure, and domestic income distribution. Formally, we model two‐dimensional worker heterogeneity and show that the second moments of the distribution of skills are critical, as in the Roy model.
Innis Lecture: Canadian Policies for Broad-Based Prosperity
The Canadian Journal of Economics / Revue canadienne d'Economique. November 2008.
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Canadian policy makers operate in the fog of myth, a myth that has been repeated so often it is mistaken for truth. According to this myth there is only one path to prosperity, and if we are to successfully travel this path, first charted by Americans, then we must abandon our most disadvantaged. We must sacrifice our core Canadian values of community and caring on the altar of competitiveness. Yet the facts of the last three decades scream out against this myth. Over that time Canada's per capita GDP fell by almost 20% relative to the United States. And this sacrifice of prosperity did not make us a more caring society. Instead, it depleted our fiscal resources by a staggering $68 billion per year and left us without the wherewithal to take care of our most disadvantaged. In this paper I debunk the myth that there is a trade-off between a prosperous society and a caring society. In place of the myth I offer up a cohesive picture of what ails Canada and how we can cure it.
Les architectes de la politique au Canada opèrent dans le brouillard d'un mythe, un mythe qui a été tellement répété qu'on le prend souvent à tort pour une vérité. Selon ce mythe, il n'y a qu'une voie vers la prospérité, et si l'on veut voyager avec succès sur cette voie, cartographiée d'abord par les Américains, on doit abandonner nos plus désavantagés à leur sort. On doit sacrifier nos valeurs de base de communauté et de compassion sur l'autel de la compétitivité. Or les expériences des dernières décennies s'inscrivent en faux contre ce mythe. Au cours de cette période, le PIB per capita au Canada a chuté de 20% par rapport à celui des Etats-Unis. Et ce sacrifice de prospérité n'a pas accru le niveau de compassion. Au contraire, nos ressources fiscales ont chuté de $68 milliards par année, et nous ont laissé moins capables de nous occuper des plus désavantagés. Dans ce texte, l'auteur s'attaque au mythe qu'il faut faire un choix entre une société de prospérité ou une société de compassion. Pour remplacer ce mythe, il met en place un diagnostic cohérent des maux qui affligent le Canada et des moyens pour les guérir.
Quality is free: A cost-benefit analysis of early child development initiatives
Paediatrics & Child Health. December 2009.
Winner of the Nori MacDonald Award recognizing an author whose article in Paediatrics & Child Health has positively affected paediatrics, such as by raising awareness of an issue, presenting new scientific research, or instigating or potentially instigating change.
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High-quality early child development initiatives are expensive. However, careful analysis of the returns on investment for such initiatives establishes that, from the government’s perspective, the initiatives all but pay for themselves. The explanation for this is twofold. First, early childhood interventions enhance adult employability and earnings of program participants. This generates $8.2 billion in tax revenues that partially offset program costs. Second, early childhood interventions reduce the need for expensive remedial programs such as special education and medical treatment, reducing government expenditures by $4.9 billion.
Improved Access to Foreign Markets Raises Plant-level Productivity…For Some Plants
With Alla Lileeva. The Quarterly Journal of Economics. August 2010.
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Market size matters for innovation and hence for productivity. Improved access to foreign markets will thus encourage firms to simultaneously export and invest in raising productivity. We examine this insight using the responses of Canadian plants to the elimination of U.S. tariffs. Unique “plant-specific” tariff cuts serve as an instrument for changes in exporting. We find that Canadian plants that were induced by the tariff cuts to start exporting or to export more (a) increased their labor productivity, (b) engaged in more product innovation, and (c) had higher adoption rates for advanced manufacturing technologies. Further, these responses were heterogeneous.
Gains from Trade when Firms Matter
With Marc J. Melitz. Journal of Economic Perspectives. Spring 2012.
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The rising prominence of intra-industry trade and huge multinationals has transformed the way economists think about the gains from trade. In the past, we focused on gains that stemmed either from endowment differences (wheat for iron ore) or inter-industry comparative advantage (David Ricardo's classic example of cloth for port). Today, we focus on three sources of gains from trade: 1) love-of-variety gains associated with intra-industry trade; 2) allocative efficiency gains associated with shifting labor and capital out of small, less-productive firms and into large, more-productive firms; and 3) productive efficiency gains associated with trade-induced innovation. This paper reviews these three sources of gains from trade both theoretically and empirically. Our empirical evidence will be centered on the experience of Canada following its closer economic integration in 1989 with the United States—the largest example of bilateral intra-industry trade in the world—but we will also describe evidence for other countries.
Domestic Institutions as a Source of Comparative Advantage
With Nathan Nunn. Handbook of International Economics. 2014.
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Domestic institutions can have profound effects on international trade. This chapter reviews the theoretical and empirical underpinnings of this insight. Particular attention is paid to contracting institutions and to comparative advantage, where the bulk of the research has been concentrated. We also consider the reverse causation running from comparative advantage to domestic institutions.
International Trade and Institutional Change: Medieval Venice’s Response to Globalization
With Diego Puga. The Quarterly Journal of Economics. May, 2014.
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International trade can have profound effects on domestic institutions. We examine this proposition in the context of medieval Venice circa 800–1600. Early on, the growth of long-distance trade enriched a broad group of merchants who used their newfound economic muscle to push for constraints on the executive, that is, for the end of a de facto hereditary Doge in 1032 and the establishment of a parliament in 1172. The merchants also pushed for remarkably modern innovations in contracting institutions that facilitated long-distance trade, for example, the colleganza. However, starting in 1297, a small group of particularly wealthy merchants blocked political and economic competition: they made parliamentary participation hereditary and erected barriers to participation in the most lucrative aspects of long-distance trade. Over the next two centuries this led to a fundamental societal shift away from political openness, economic competition, and social mobility and toward political closure, extreme inequality, and social stratification. We document this oligarchization using a unique database on the names of 8,178 parliamentarians and their families’ use of the colleganza in the periods immediately before and after 1297. We then link these families to 6,959 marriages during 1400–1599 to document the use of marriage alliances to monopolize the galley trade. Monopolization led to the rise of extreme inequality, with those who were powerful before 1297 emerging as the undisputed winners.
Capabilities, Wealth, and Trade
With John Sutton. Journal of Political Economy. May, 2016.
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We explore the relation between a country’s income and the mix of products it exports. Both are simultaneously determined by countries’ capabilities, that is, by countries’ productivity and quality levels for each good. Our theoretical setup has two features. (1) Some goods have fewer high-quality producers/countries than others, meaning that there is comparative advantage. (2) Imperfect competition allows high- and low-quality producers to coexist. These two features generate an inverted-U, general equilibrium relationship between a country’s export mix and its GDP per capita. We show that this inverted-U permeates the international data on trade and GDP per capita.
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Endowments, Skill-Biased Technology, and Factor Prices: A Unified Approach to Trade
With Peter Morrow. China Development Journal 2026.
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We develop a multi-factor, multi-sector Eaton-Kortum model in order to examine the impact of trade costs, factor endowments, and technol ogy (both Ricardian and factor-augmenting) on factor prices, trade in goods, and trade in the services of primary factors (value-added trade). This framework nests the Heckscher-Ohlin-Vanek (HOV) model and the Vanek factor content of trade prediction. We take the model to the data using skilled and unskilled data for 38 countries. We have two findings. First, the key determinants of international variation in the factor content of trade are endowments and international variation in factor inputs used per dollar of output. Input-usage variation in turn is driven by (1) factor-augmenting international technology differences and (2) international factor price differences. Second, our estimates of factor-augmenting international technology differences — which imply cross-country variation in skill-biased technologies — are empirically similar to those used to rationalize cross-country evidence on income differences and directed technical change.
The impact of AI and cross-border data regulation on international trade in digital services
With Ruiqi Sun. Journal of International Economics. 2026.
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International trade in digital services, including mobile app trade (e.g., Facebook in Frankfurt, Instagram in Istanbul), is large and rapidly growing. Analysing 2015–2020 data on 28,000 mobile apps, we find that AI increases an app’s user base threefold, a massive effect. AI’s handmaiden is data, including cross-border flows of personal data. Concerned with privacy and national security, policymakers have responded with thousands of conflicting data regulations, ranging from guaranteeing free trade in data (USMCA) to data export bans. We are the first to show that these regulations matter: AI’s massive effect is halved in countries with strict data flow restrictions.
Heckscher-Ohlin Theory
In Priyaranjan Jha and Devashish Mitra (eds.) Elgar Encyclopedia of International Trade, Edward Elgar Publishing, 2026.
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The Heckscher-Ohlin (HO) theory explains how a country’s abundance of labor, capital, and other resources shapes its comparative advantage in trade. Developed by Eli Heckscher (1919) and Bertil Ohlin (1933), the theory states that countries export goods that rely heavily on their abundant resources and import goods that depend on resources they lack. For instance, a country abundant in skilled labor is likely to export products like computers, which require high levels of expertise, while importing labor-intensive goods like clothing. The theory also offers insights into wage differences between skilled and unskilled workers (a measure of inequality) and how these gaps shift in response to trade patterns and trade policies. This essay reviews the model’s implications for trade, development, and inequality, as well as the vast empirical research that assesses how a country’s resources shape its trade patterns and labor dynamics.
How Do Endowments Determine Trade? Quantifying the Output Mix, Factor Price and Skill-Biased Technology Channels
With Peter Morrow. Journal of International Trade 2022.
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We develop a multi-factor, multi-sector Eaton-Kortum model in order to examine the impact of trade costs, factor endowments, and technol ogy (both Ricardian and factor-augmenting) on factor prices, trade in goods, and trade in the services of primary factors (value-added trade). This framework nests the Heckscher-Ohlin-Vanek (HOV) model and the Vanek factor content of trade prediction. We take the model to the data using skilled and unskilled data for 38 countries. We have two findings. First, the key determinants of international variation in the factor content of trade are endowments and international variation in factor inputs used per dollar of output. Input-usage variation in turn is driven by (1) factor-augmenting international technology differences and (2) international factor price differences. Second, our estimates of factor-augmenting international technology differences — which imply cross-country variation in skill-biased technologies — are empirically similar to those used to rationalize cross-country evidence on income differences and directed technical change.
What’s the big idea? Multi-function products, firm scope and firm boundaries
With Mengxiao Liu. Journal of Economic Behavior and Organization. December, 2020.
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Products often bundle together many functions, e.g., smartphones. The firm develops the big idea (which functions to bundle) and then chooses one supplier per function. We assume there is a holdup problem and prove that the firm’s bargaining power (Shapley value) is declining in the number of suppliers. Greater scope as measured by the number of suppliers exacerbates holdup, but this can be partially offset by the appropriate choice of vertical integration or outsourcing. Our main result flows from the empirical observation that the number of functions varies across products within an industry (firm heterogeneity). We introduce the notion of an ‘ideas-oriented’ industry as one in which more productive firms have higher marginal returns to introducing a new function. This leads to two testable hypotheses. More productive firms will (1) have more suppliers and (2) be more likely to integrate those suppliers. We take this to the data by training a multilayer perceptron to predict whether or not each of 29 million PATSTAT patent applications involves new/improved functions. We merge these patents with S&P Capital IQ data on 55,000 companies and their supplier networks. We show that in industries where patents are skewed towards new or improved functions, more productive firms have more suppliers and are more likely to integrate these suppliers.
The Rents from Trade and Coercive Institutions
With Christian Dippel & Avner Greif. The Economic Journal. August, 2020.
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In economies with a large informal sector firms can increase profits by reducing workers’ outside options in that informal sector. We formalise this idea in a simple model of an agricultural economy with plantation owners who lobby the government to enact coercive policies—e.g., the eviction and incarceration of squatting smallhold farmers—that reduce the value to working outside the formal sector. Using unique data for 14 British West Indies ‘sugar islands’ from 1838 (the year of slave emancipation) until 1913, we examine the impact of plantation owners’ power on wages and coercion-related incarceration. To gain identification, we utilise exogenous variation in the strength of the plantation system in the different islands over time. Where planter power declined we see that incarceration rates dropped, and agricultural wages rose, accompanied by a decline in formal agricultural employment.
Implications of Canada’s restrictive FDI policies on employment and productivity
With Walid Hejazi. Journal of International Business Policy. April, 2019.
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The merits of foreign direct investment (FDI) have been well documented, thus explaining the openness of many countries to foreign capital. There is, however, some debate on the importance of FDI into key basic business services sectors such as financial services, air transportation services, and telecom services, which remain protected in many countries, including Canada. These restrictions, together with the presence of a review mechanism for foreign investment, has resulted in Canada being ranked above average in terms of restrictiveness by the OECD. We estimate that a leveling down of Canadian FDI restrictions to average OECD levels would raise Canadian labor productivity by a very large 0.79%. It would also either raise employment by 137,400 jobs or raise annual earnings for each Canadian worker by CA$648, or $9.6 billion economy-wide. These results therefore highlight the merits of FDI to local economies.
The China-OECD trade divide: building bridges
China Economic Journal. April, 2019.
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Today’s largest trade frictions stem from differences between China and the OECD regarding the appropriate role of government. There are two types of differences. The first are legitimate attitudinal differences towards industrial policy (the use of subsidies), competition policy (the use of forced industry consolidation), and innovation policy (weak protections of intellectual property). China and the OECD will have to reach an accommodation on these differences if the end game is a rules-based trading system. Accommodation is possible, but unfortunately, both the US and China are adopting bullying tactics that diminish the effectiveness of the WTO and threaten the current rules-based system. The second class of differences is political and reflects China’s intentional lack of policy transparency and its generosity towards favoured firms. These differences will never be WTO compliant and China must either reform or give up its access to OECD markets.
A sorted tale of globalization: White collar jobs and the rise of service offshoring
With Runjuan Liu. Journal of International Economics. April, 2019.
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We study how the rise of unaffiliated trade in services with China and India has impacted U.S. labour markets. The topic has two understudied aspects: it deals with service trade (most studies deal with manufacturing trade) and it examines the historical first of U.S. workers competing with educated but low-wage foreign workers. Our empirical agenda is made complicated by the endogeneity of service imports and the endogenous sorting of workers across occupations. To develop an estimation framework that deals with these, we imbed a partial equilibrium model of ‘trade in tasks’ within a general equilibrium model of occupational choice. The model highlights the need to estimate labour market outcomes using changes in the outcomes of individual workers and, in particular, to distinguish workers who switch ‘up’ from those who switch ‘down’. (Switching ‘down’ means switching to an occupation that pays less on average than the current occupation). We apply these insights to matched CPS data for 1996–2007. The cumulative 10-year impact of rising service imports from China and India has been as follows. (1) Downward occupational switching increased by 7 percentage points, from 21% to 28%, and upward occupational switching increased by 6 percentage points, from 17% to 23%. (2) Transitions to unemployment were imprecisely measured to have increased by half a percentage point, potentially raising the white-collar unemployment rate from 3.0% to 3.5%. (3) The earnings average across all white collar workers fell by a small 1%. However, for the sub-population of workers who switched down or became unemployed, earnings fell by 15% and 47%, respectively. (4) Service exports had partially offsetting effects on switching and unemployment.
Estimating Productivity Using Chinese Data: Methods, Challenges and Results
With Scott Orr and Miaojie Yu. In World Trade Evolution: Growth, Productivity and Employment, edited by Lili Yang Ing and Miaojie Yu, Routledge, NY, 2019
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This chapter reviews some state-of-the-art methods for estimating productivity, always adopting a practitioner's perspective. It details the state-of-the-art methods to Chinese manufacturing data over the 2000–2006 period. The chapter estimates dozens of different specifications for 28 industries for a total of 672 production function estimates. It compares results across specifications and draws the strengths and pitfalls of each. The chapter describes the basic model underlying the estimation routine. It provides a line-by-line guide to all of the details that practitioners need, including some common extensions such as correcting for attrition bias and the impact of exporting on productivity. The magnitude of productivity dispersion within an industry is a question of substantive economic interest since industries with greater productivity dispersion have a greater scope for across-firm allocative productivity gains. The chapter examines the correlation between sales and productivity. One can assess the impact of exporting on productivity by examining the export dummy coefficient in the evolution-of-productivity equation.
A broad range of experts who have contributed to this PIIE Briefing say “yes.” The new negotiations can succeed only if they focus on how the agreement can be updated and upgraded, however. NAFTA can be modernized only if President Trump’s zero-sum “America First” agenda is replaced by one that seeks to benefit all three countries and improve their competitiveness in an increasingly competitive global economy. Prioritizing American interests is of course essential in any US trade negotiation. But an obsessive concern about bilateral trade balances and narrow special interests in the United States, as opposed to broader national and regional interests, would not only deadlock the negotiations but also likely lead to inferior outcomes for all three countries, or even a breakdown in the talks and an abrogation of the agreement. And walking away from NAFTA altogether would be disastrous for consumers, producers, and retailers in the United States. As argued in several chapters of this Briefing, abandoning NAFTA would degrade regional competitiveness and terminate jobs across North America, undoing the integration achieved since the agreement’s inception.
Modernizing NAFTA: A Canadian Perspective
With Wendy Dobson & Julia Tory. Peterson Institute for International Economics. July, 2017.
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The North American Free Trade Agreement (NAFTA) ranks at the top of anyone’s list of the most controversial trade deals of all time. Reviled by critics as unfair and as a job destroyer, praised by its defenders as having a documented record of success in spurring economic growth, NAFTA reduced tariff barriers to zero for the United States, Mexico, and Canada and led to a tripling of trade among these three countries over the last 23 years. The Peterson Institute for International Economics (PIIE) has abundantly detailed the many gains and acknowledged costs of NAFTA in numerous publications. Now that President Donald Trump has launched a renegotiation of NAFTA—having at least for the moment abandoned his 2016 campaign pledge to cancel the pact outright—the fundamental question is: Can such a renegotiation produce a positive result?
A broad range of experts who have contributed to this PIIE Briefing say “yes.” The new negotiations can succeed only if they focus on how the agreement can be updated and upgraded, however. NAFTA can be modernized only if President Trump’s zero-sum “America First” agenda is replaced by one that seeks to benefit all three countries and improve their competitiveness in an increasingly competitive global economy. Prioritizing American interests is of course essential in any US trade negotiation. But an obsessive concern about bilateral trade balances and narrow special interests in the United States, as opposed to broader national and regional interests, would not only deadlock the negotiations but also likely lead to inferior outcomes for all three countries, or even a breakdown in the talks and an abrogation of the agreement. And walking away from NAFTA altogether would be disastrous for consumers, producers, and retailers in the United States. As argued in several chapters of this Briefing, abandoning NAFTA would degrade regional competitiveness and terminate jobs across North America, undoing the integration achieved since the agreement’s inception.
Capabilities, Wealth, and Trade
With John Sutton. Journal of Political Economy. May, 2016.
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We explore the relation between a country’s income and the mix of products it exports. Both are simultaneously determined by countries’ capabilities, that is, by countries’ productivity and quality levels for each good. Our theoretical setup has two features. (1) Some goods have fewer high-quality producers/countries than others, meaning that there is comparative advantage. (2) Imperfect competition allows high- and low-quality producers to coexist. These two features generate an inverted-U, general equilibrium relationship between a country’s export mix and its GDP per capita. We show that this inverted-U permeates the international data on trade and GDP per capita.
International Trade and Institutional Change: Medieval Venice’s Response to Globalization
With Diego Puga. The Quarterly Journal of Economics. May, 2014.
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International trade can have profound effects on domestic institutions. We examine this proposition in the context of medieval Venice circa 800–1600. Early on, the growth of long-distance trade enriched a broad group of merchants who used their newfound economic muscle to push for constraints on the executive, that is, for the end of a de facto hereditary Doge in 1032 and the establishment of a parliament in 1172. The merchants also pushed for remarkably modern innovations in contracting institutions that facilitated long-distance trade, for example, the colleganza. However, starting in 1297, a small group of particularly wealthy merchants blocked political and economic competition: they made parliamentary participation hereditary and erected barriers to participation in the most lucrative aspects of long-distance trade. Over the next two centuries this led to a fundamental societal shift away from political openness, economic competition, and social mobility and toward political closure, extreme inequality, and social stratification. We document this oligarchization using a unique database on the names of 8,178 parliamentarians and their families’ use of the colleganza in the periods immediately before and after 1297. We then link these families to 6,959 marriages during 1400–1599 to document the use of marriage alliances to monopolize the galley trade. Monopolization led to the rise of extreme inequality, with those who were powerful before 1297 emerging as the undisputed winners.
Domestic Institutions as a Source of Comparative Advantage
With Nathan Nunn. Handbook of International Economics. 2014.
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Domestic institutions can have profound effects on international trade. This chapter reviews the theoretical and empirical underpinnings of this insight. Particular attention is paid to contracting institutions and to comparative advantage, where the bulk of the research has been concentrated. We also consider the reverse causation running from comparative advantage to domestic institutions.
Incomplete contracts and the boundaries of the multinational firm
With Nathan Nunn. Journal of Economic Behavior & Organization. October 2013.
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Using data on U.S. intra-firm and arm's-length imports for 5705 products imported from 220 countries, we examine the determinants of the share of U.S. imports that are intra-firm. We examine two predictions that arise from Antràs (2003), Antràs and Helpman (2008) and Antràs and Helpman (2004). First, we find that, consistent with the implicit logic of Antràs (2003) and the explicit predictions of Antràs and Helpman (2008), vertical integration is increasing in the importance of non-contractible headquarter inputs relative to non-contractible supplier inputs. In other words, we show that only non-contractible headquarter inputs affect the firm's make-or-buy decision. Second, we also provide empirical support for the Antràs and Helpman (2004) prediction that intra-firm trade is largest where non-contractible headquarter inputs are important and productivity is high.
Gains from Trade when Firms Matter
With Marc J. Melitz. Journal of Economic Perspectives. Spring 2012.
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The rising prominence of intra-industry trade and huge multinationals has transformed the way economists think about the gains from trade. In the past, we focused on gains that stemmed either from endowment differences (wheat for iron ore) or inter-industry comparative advantage (David Ricardo's classic example of cloth for port). Today, we focus on three sources of gains from trade: 1) love-of-variety gains associated with intra-industry trade; 2) allocative efficiency gains associated with shifting labor and capital out of small, less-productive firms and into large, more-productive firms; and 3) productive efficiency gains associated with trade-induced innovation. This paper reviews these three sources of gains from trade both theoretically and empirically. Our empirical evidence will be centered on the experience of Canada following its closer economic integration in 1989 with the United States—the largest example of bilateral intra-industry trade in the world—but we will also describe evidence for other countries.
The Structure of Tariffs and Long-Term Growth
With Nathan Nunn. American Economic Journal: Macroeconomics. October 2010.
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We show that the "skill bias" of a country's tariff structure is positively correlated with long-term per capita GDP growth. Testing for causal mechanisms, we find evidence consistent with the existence of real benefits from tariffs focused in skill-intensive industries. However, this only accounts for a quarter of the total correlation between skill-biased tariffs and growth. Turning to alternative explanations, we extend the standard Grossman-Helpman "protection-for- sale" model and show how the skill bias of tariffs can reflect the extent of domestic rent-seeking activities in the economy. We provide evidence that the remaining variation is explained by this endogeneity.
Improved Access to Foreign Markets Raises Plant-level Productivity…For Some Plants
With Alla Lileeva. The Quarterly Journal of Economics. August 2010.
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Market size matters for innovation and hence for productivity. Improved access to foreign markets will thus encourage firms to simultaneously export and invest in raising productivity. We examine this insight using the responses of Canadian plants to the elimination of U.S. tariffs. Unique “plant-specific” tariff cuts serve as an instrument for changes in exporting. We find that Canadian plants that were induced by the tariff cuts to start exporting or to export more (a) increased their labor productivity, (b) engaged in more product innovation, and (c) had higher adoption rates for advanced manufacturing technologies. Further, these responses were heterogeneous.
The structure of factor content predictions
With Susan Chun Zhu. Journal of International Economics. July 2010.
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The last decade witnessed an explosion of research into the impact of international technology differences on the factor content of trade. Yet the literature has failed to confront two pivotal issues. First, with international technology differences and traded intermediate inputs, there is no existing definition of the factor content of trade that is compatible with Vanek's factor content prediction. We fill this gap. Second, as Helpman and Krugman (1985) showed, many models beyond Heckscher-Ohlin imply the Vanek prediction. Thus, absent a complete list of these models, we do not fully know what models are being tested when the Vanek prediction is tested. We completely characterize the class of models being tested by providing a familiar consumption similarity condition that is necessary and sufficient for a robust Vanek prediction. Finally, we reassess the performance of the prediction using the correct factor content definition and input–output tables for 41 countries. We find that the prediction performs well except for the presence of missing trade. Further, missing trade is not pervasive: it is associated entirely with ‘home bias’ in the consumption of agricultural goods, government services and construction.
Wake up and smell the ginseng: International trade and the rise of incremental innovation in low-wage countries
With Diego Puga. Journal of Development Economics. January 2010.
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Increasingly, a small number of low-wage countries such as China and India are involved in incremental innovation. That is, they are responsible for resolving production-line bugs and suggesting product improvements. We provide evidence of this new phenomenon and develop a model in which there is a transition from old-style product-cycle trade to trade involving incremental innovation in low-wage countries. The model explains why levels of involvement in incremental innovation vary across low-wage countries and across firms within each low-wage country. We draw out implications for sectoral earnings, living standards, the capital account and, foremost, international trade in goods.
Quality is free: A cost-benefit analysis of early child development initiatives
Paediatrics & Child Health. December 2009.
Winner of the Nori MacDonald Award recognizing an author whose article in Paediatrics & Child Health has positively affected paediatrics, such as by raising awareness of an issue, presenting new scientific research, or instigating or potentially instigating change.
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High-quality early child development initiatives are expensive. However, careful analysis of the returns on investment for such initiatives establishes that, from the government’s perspective, the initiatives all but pay for themselves. The explanation for this is twofold. First, early childhood interventions enhance adult employability and earnings of program participants. This generates $8.2 billion in tax revenues that partially offset program costs. Second, early childhood interventions reduce the need for expensive remedial programs such as special education and medical treatment, reducing government expenditures by $4.9 billion.
Innis Lecture: Canadian Policies for Broad-Based Prosperity
The Canadian Journal of Economics / Revue canadienne d'Economique. November 2008.
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Canadian policy makers operate in the fog of myth, a myth that has been repeated so often it is mistaken for truth. According to this myth there is only one path to prosperity, and if we are to successfully travel this path, first charted by Americans, then we must abandon our most disadvantaged. We must sacrifice our core Canadian values of community and caring on the altar of competitiveness. Yet the facts of the last three decades scream out against this myth. Over that time Canada's per capita GDP fell by almost 20% relative to the United States. And this sacrifice of prosperity did not make us a more caring society. Instead, it depleted our fiscal resources by a staggering $68 billion per year and left us without the wherewithal to take care of our most disadvantaged. In this paper I debunk the myth that there is a trade-off between a prosperous society and a caring society. In place of the myth I offer up a cohesive picture of what ails Canada and how we can cure it.
Les architectes de la politique au Canada opèrent dans le brouillard d'un mythe, un mythe qui a été tellement répété qu'on le prend souvent à tort pour une vérité. Selon ce mythe, il n'y a qu'une voie vers la prospérité, et si l'on veut voyager avec succès sur cette voie, cartographiée d'abord par les Américains, on doit abandonner nos plus désavantagés à leur sort. On doit sacrifier nos valeurs de base de communauté et de compassion sur l'autel de la compétitivité. Or les expériences des dernières décennies s'inscrivent en faux contre ce mythe. Au cours de cette période, le PIB per capita au Canada a chuté de 20% par rapport à celui des Etats-Unis. Et ce sacrifice de prospérité n'a pas accru le niveau de compassion. Au contraire, nos ressources fiscales ont chuté de $68 milliards par année, et nous ont laissé moins capables de nous occuper des plus désavantagés. Dans ce texte, l'auteur s'attaque au mythe qu'il faut faire un choix entre une société de prospérité ou une société de compassion. Pour remplacer ce mythe, il met en place un diagnostic cohérent des maux qui affligent le Canada et des moyens pour les guérir.
Sorting It Out: International Trade with Heterogeneous Workers
With Franziska Ohnsorge. Journal of Political Economy. October 2007.
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Each worker brings a bundle of skills to the workplace, for example, quantitative and communication skills. Since employers must take this bundle as a package deal, they choose workers with just the right mix of skills. We show that international differences in the distribution of worker skill bundles—for example, Japan’s abundance of workers with a modest mix of both quantitative and teamwork skills—have important implications for international trade, industrial structure, and domestic income distribution. Formally, we model two‐dimensional worker heterogeneity and show that the second moments of the distribution of skills are critical, as in the Roy model.
The New World Division of Labor
With Elhanan Helpman. Prepared for a Conference on Offshore Outsourcing. July 2006.
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This policy brief is a summary of the views on offshore outsourcing expressed by Canadian and international thought leaders at two conferences co-organized by Industry Canada and the Rotman School of Management. The “Roundtable on Offshoring” was held on March 30, 2005 at the Chateau Laurier, Ottawa and led to the commissioning of 16 new studies that fully describe all that is relevant to Canadian policy makers about the rise of offshore outsourcing. The papers were then presented at a conference held on October 26-27, 2006 at the Rotman School of Management, University of Toronto.
Offshoring: Threats and Opportunities
Brookings Trade Forum. May 2005.
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The recent spectacular increase in trade volumes poses large challenges to businesses and workers who must adjust to a new level of global competition. This by itself does not call for a complete rethinking of U.S. trade policy. What does pose a new policy dilemma is the rise of service offshoring. Service offshoring is the use of work ers located abroad to provide sophisticated services to U.S. customers. Service offshoring is currently small. As it grows it will undoubtedly have important effects on America. However, the real concern is that in the longer run of 10-20 years, Chinese and Indian exports will devastate the United States. This concern is misplaced for two reasons. First, it ignores the ironclad law of comparative advantage which states that no country can export all goods. Second, it ignores the fact that weak in stitutions in these countries will retard the rate at which these countries develop as powerhouses of innovation.
Policy Responses to the New Offshoring: Think Globally, Invest Locally
Prepared for Industry Canada’s March 30, 2005 Roundtable on Offshoring. April 2005.
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This paper examines the issues surrounding outsourcing and offshoring of goods and services. In considering international offshoring, two trends stand out. The first is the rise of China as the world’s manufacturer. The second is the rapid growth of traded services involving innovative, technology-intensive processes and employing high-paid white collar workers. Offshoring enables firms to concentrate on core activities and their competitiveness. Thus, the paper argues that offshoring is both a threat and an opportunity. Many Canadian firms have yet to recognize the sea change in their sourcing possibilities. Better information about the strategic offshoring option is needed. Offshoring has important policy implications for Canada and other major economies. The building blocks for globally competitive Canadian firms are domestic policies that encourage investment in upgrading and innovation by individuals (i.e. human capital) and firms (i.e. research and development and advance technologies).
The Long and Short of the Canada-U.S. Free Trade Agreement
American Economic Review. September 2004.
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The Canada-U. S. Free Trade Agreement provides a unique window onto the effects of a reciprocal trade agreement on an industrialized economy (Canada). For industries that experienced the deepest Canadian tariff cuts, the contraction of low-productivity plants reduced employment by 12 percent while raising industrylevel labor productivity by 15 percent. For industries that experienced the largest U. S. tariff cuts, plant-level labor productivity soared by 14 percent. These results highlight the conflict between those who bore the short-run adjustment costs (displaced workers and struggling plants) and those who are garnering the long-run gains (consumers and efficient plants).
Increasing Returns to Scale and All That: A View From Trade
American Economic Review. September 2002.
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Do scale economies help to explain international trade flows? Using a large database on output, trade flows, and factor endowments, we find that allowing for the presence of increasing returns to scale in production significantly increases our ability to predict international trade flows. In particular, using trade data, we find that a third of al goods-producing industries are characterized by increasing returns ot scale. Thus, scale economies are a quantifiable and important source of comparative advantage.
A Time To Sow, A Time To Reap: The FTA and its Impact on Productivity and Employment
With Gary Sawchuk. Industry Canada. June 2001.
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The Canada-U.S. Free Trade Agreement (FTA) remains one of the most contentious pieces of economic legislation ever enacted in Canada. Remarkably, the FTA is far from being viewed as a success by either end of the political spectrum. The Canadian Labour Congress fingers the Agreement as the cause of job losses that tragically racked manufacturing in the early 1990s (Jackson, 1996). And even the business community complains about the ultimate FTA failure: lagging productivity growth (Rubin, 1997) in apparent contradiction to the forecasted improvements in productivity that have always been at the heart of the proclaimed benefits. While the nay-sayers dominate public discussion, the arguments, pro and con, have often been devoid of hard facts, despite efforts taken by the research community to provide evidence and thoughtful analysis on the matter e.g., Gaston and Trefler (1994, 1997), Trefler (1997), Head and Ries (1997, 1999a, 1999b), Feinberg and Keane (1998), Feinberg, Keane and Bognanno (1998) and Beaulieu (2000). Clearly, the court of public opinion is not easily convinced. The jury remains out on whether the FTA productivity benefits live up to their promise and whether these benefits compensate sufficiently for any employment and business losses. Consequently, the question still beckons: is it possible to summon clear, convincing evidence of the FTAs impact? Is it possible to separate out the real from the perceived and facts from appearance?
The Case of the Missing Trade and Other Mysteries
The American Economic Review. December 1995.
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The Heckscher-Ohlin-Vanek (HOV) theorem, which predicts that countries will export products that are made from factors in great supply, performs poorly. However, deviations from HOV follow pronounced patterns. Trade is missing relative to its HOV prediction. Also, rich countries appear scarce in most factors and poor countries appear abundant in all factors, a fact that squares poorly with the HOV prediction that abundant factors are exported. As suggested by the patterns, HOV is rejected empirically in favor of a modification that allows for home bias in consumption and international technology differences.
International Factor Price Differences: Leontief was Right!
Journal of Political Economy. December 1993.
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The factor price equalization hypothesis is widely at odds with the large variation in factor prices across countries. Similarly, the Heckscher-Ohlin-Vanek (HOV) theorem constitutes an incomplete description of trade in factor services: its predictions are always rejected empirically. These two issues are examined using a modification of the HOV model that allows for factor-augmenting international productivity differences. The empirical results are stark: this simple modification of the HOV theorem explains much of the factor content of trade and the cross-country variation in factor prices.
Trade Liberalization and the Theory of Endogenous Protection: An Econometric Study of U.S. Import Policy
Journal of Political Economy. February 1993.
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Trade theorists continue to puzzle over their surprisingly small estimates of the impact of trade liberalization on imports. All explanations of the puzzle treat trade liberalization as a given. But the level of trade protection is not exogenous. The theory of endogenous protection predicts that higher levels of import penetration will lead to greater protection. This paper finds that when trade protection is modeled endogenously, its restrictive impact on imports is large, 10 times the size obtained from treating protection exogenously.
Books
Offshore Outsourcing: Capitalizing on Lessons Learned
Edited by Daniel Trefler. Toronto: Rotman School of Management and Industry Canada, 2010.
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This policy brief is a summary of the views on offshore outsourcing expressed by Canadian and international thought leaders at two conferences co-organized by Industry Canada and the Rotman School of Management. The “Roundtable on Offshoring” was held on March 30, 2005 at the Chateau Laurier, Ottawa and led to the commissioning of 16 new studies that fully describe all that is relevant to Canadian policy makers about the rise of offshore outsourcing. The papers were then presented at a conference held on October 26-27, 2006 at the Rotman School of Management, University of Toronto.
From these papers and the lively conference debates comes a comprehensive inventory of possible policy responses to the rise of offshore outsourcing. These policies are reviewed here and the effectiveness of each is evaluated. Section 4 of the paper is particularly important as it presents the most effective policies, namely, those that are proactive. The key proactive issue is Canada’s ability to sell innovative products abroad. This ability is being threatened by increased offshore outsourcing to low-wage countries such as China and India and the threat will become a major one if and when these low-wage countries become major innovators. The right policy mix must address Canada’s current innovation gap.