from ricardo to brexit and beyond - university of...

From Ricardo to Brexitand Beyond

J. Peter Neary

University of Oxford, CEPR, and CESifo

Esmee Fairbairn LectureUniversity of Lancaster

November 28, 2017

J.P. Neary (Oxford) Ricardo to Brexit Nov. 28, 2017 1 / 29

Introduction

Trade@200

David Ricardo, 1772-1823

“On the Principles of Political Economy and Taxation” (1817)


Introduction

Ricardo the Man

Born into an immigrant family

Successful stockbroker

Country gentleman

Liberal parliamentarian


Introduction

Outline

1 The Dawn of Economic Theory

2 David Ricardo’s Big Idea: Trade and Comparative Advantage

3 Trade and Income Distribution

4 What Ricardo Didn’t Know

5 Policy Relevance

6 Conclusion


The Dawn of Economic Theory

Outline





5 Policy Relevance

6 Conclusion


The Dawn of Economic Theory

Economics as a Science

David Ricardo: The Founder of Economic Theory

Deliberately simplified assumptions ...

... plus abstract reasoning ...

... ... leading to general principles

The second essential ingredient for economics as a science

The first: Adam Smith’s broad perspective and concern with empirics

Especially important to the theory of international trade

Provided canonical answers to two of the three main questions in thefield


David Ricardo’s Big Idea: Trade and Comparative Advantage

Outline





5 Policy Relevance

6 Conclusion



Before Ricardo: Trade Theory 0.0

Trade Theory 0.0: Mercantilism

Exports and trade surpluses are good, imports are bad

A zombie theory:

Trump: “American carnage”; “protection will lead to great prosperity”

Peter Navarro (Director, White House National Trade Council):“Death by China” (2011)



Before Ricardo: Trade Theory 1.0

Trade Theory 1.0: Absolute Advantage (Adam Smith)

A big advance over mercantilism

A central determinant of absolute living standards and trade volumes

But, as a theory of trade patterns: clear, simple, and wrong!

The curse of common sense!Europe is more efficient at producing cars than China ...... so Europe should export cars to China. Right?But isn’t “efficiency” measured in real terms (e.g., labour productivity)?And Europe is also more efficient at producing textiles than China ...... so Europe should also export textiles to China?But Chinese wages are much lower, so it produces textiles more cheaplyAhhhh! So it’s all about “efficiency” measured in money terms?But at Chinese wages, they could produce cars more cheaply ...

And indulges common-sense prejudices:Europe is exploiting poor countries because it is more efficient... or ...China is competing unfairly: its wages and/or its currency are too low



Trade Theory 2.0: Comparative Advantage

Ricardo’s Big Idea: Comparative Advantage

Counter-intuitive

Samuelson: “thousands of important and intelligent men [sic] ... havenever been able to grasp the doctrine for themselves or to believe itafter it was explained to them.”

Emphasises not just differences, but differences in differences:[Costinot (2009)]

Relative to China, Europe is relatively more efficient at producing carsthan textiles ...... so Europe will export cars, China textiles.Double difference gets rid of exchange rates, wages, etc.They matter, but not for composition of trade

Predicts trade patterns and aggregate gains from trade

Both countries gain: Trade not a zero-sum game



Comparative Advantage: The Scientific Legacy

Sets an agenda for theory and empirics

Broadly consistent with trade patterns between countries that differsignificantly

Though proper scientific confirmation took longer

Early empirical studies hampered by theory’s low dimensionality[MacDougall (1951)]

Theory needed to be generalized[Dornbusch, Fischer, and Samuelson (1977), Eaton and Kortum (2002)]

Which has allowed confirmation and quantification[Costinot, Donaldson, and Komunjer (2012)]

What about the legacy for policy?

Universal free trade?

Not really ... for reasons that Ricardo also made clear


Trade and Income Distribution

Outline





5 Policy Relevance

6 Conclusion




Ricardo’s analysis of the Corn Laws

Eliminating corn tariffs would harm landowners, help labourers

Net gains, implying that losers could be compensated ...... though they never are ...

Trade and Income Distribution 1.0

Highlights a central, “common-sensical”, mechanism

An early version of the specific-factors model[Findlay (1974)]

Later work integrated it with the theory of comparative advantage

“Stolper-Samuelson” effect: Trade liberalization by a skill-abundantcountry will harm unskilled workers

Very robust key idea: there is always at least one winner and one loser[Ethier (1974)]

Evidence of both for the U.S.[Autor, Dorn, and Hanson (2013), Feenstra and Sasahara (2017)]


What Ricardo Didn’t Know

Outline





5 Policy Relevance

6 Conclusion



Of Course, We Have Learnt a Lot Since Ricardo

1 Gravity

2 Intra-Industry Trade

3 Trade in Intermediate Goods

4 Firms in Trade

5 Big Data, Quantification, etc.



Gravity or Anti-Gravity?

Mr. Gravity Mr. Anti-Gravity

Mr. Gravity [Jim Anderson]: Vjk =(

τjkΠjPk

)1−σIjIk

IW

Mr. Anti-Gravity [Liam Fox, UK Minister for International Trade]:

“Today, we stand on the verge of an unprecedented ability to liberate global tradefor the benefit of our whole planet with technological advances dissolving away thebarriers of time and distance. It is potentially the beginning of what I might call‘post geography trading world’ where we are much less restricted in having to findpartners who are physically close to us.”



Anti-Gravity: Not Stupid ...



Anti-Gravity: Not Stupid ... Just Wrong

Has the World Become Flat?No: Overwhelming evidence that trade declines with distance

Average preferred estimate: −1.1[Head and Mayer (2014): review of 159 papers; S.D. 0.41; median −1.14]

No evidence that the effect is declining

Despite the internet, etc.: How come?Conjecture that this reduces the effect of distance uniformly

Distance even matters (though less so) for:

FDI: Keller and Yeaple (2013)Equities: Portes and Rey (2005)eBay: Lendle, Olarreaga, Schropp, and Vezina (2016)Google: Cowgill and Dorobantu (2012)



Other Things We Have Learnt

2 Intra-Industry Trade

Driven by product differentiation and increasing returns

Dominates trade between similar economies

Implies gains from increased variety

Lower costs of adjustment than inter-industry trade [Krugman (1981)]

3 Trade in Intermediate Goods

“The division of labour limited by the extent of the market”

Global and mega-regional value chains4 Firms in Trade

Heterogeneous: Minnows and superstars

Intra-firm margins of adjustment: Multi-product, multi-destination

Globalization typically implies a ”Matthew Effect”[Mrazova and Neary (2017)]

Strategic behaviour: Superstar firms are different5 Big Data, Quantification, etc.

The scientific study of international tradeJ.P. Neary (Oxford) Ricardo to Brexit Nov. 28, 2017 19 / 29

Policy Relevance

Outline





5 Policy Relevance

6 Conclusion


Policy Relevance

What are These People Doing?

A Special Relationship Shared Values

Discussing Trade Agreements of course!


Policy Relevance

Brexit: Science versus Politics, Ideology, Outrage

Trade agreements are fundamentally political/non-economicThis is a deeper kind of “political” from trade models:

Trade agreements as a way to internalise terms-of-trade externality[Bagwell and Staiger (1999)]

Trade agreements as a commitment device to restrict producer interests[Maggi and Rodrıguez-Clare (1998), Maggi, Mrazova, and Neary (2017)]

Like any international treaty, they imply some loss of sovereignty

As economists we have no right to condemn non-economic viewsBrexit is more about identity, history, belonging, than economicsSurveys suggest that many (not all) Brexit voters are willing to pay

As citizens, we have every right, but ...We should not claim too much

Project Fear? Brexit will be less Dunkirk, more Winter of Discontent

We should not abuse our position

We should declare our interestsSpeaking as a citizen ...... of Ireland, Europe, and the World


Policy Relevance

Back to the Science

Back to the Science: What is the best trade agreement for the UK?

“Global Britain”?“I don’t think it makes sense for us to pretend we should remain in the singlemarket and I think there are real question marks about whether it makessense to remain in the customs union. [Doing so ... ] could undermine thegovernment’s ability to sign trade deals with countries outside the block.”

- Mervyn King, Former Governor, Bank of England, 26 Dec. 2016

The Single Market?

The Single Market is a trade agreement!


Policy Relevance

Who to Trade With?

[Sampson (2017), Dhingra et al. (2017)]

Lessons from Ricardo:

Countries that are very different have the potential for large gains ...

... but also for greatest disruption

The ideal trade agreement:

Respecting comparative advantage – but not too much ...

Nearby - so the agreement works with gravity, not against it

Deep: Including regulation and “behind-the-border” protection

Comprehensive: Covering agriculture and services as well as industry

So, what is the ideal trade agreement for the UK?

The Single Market, of course!


Conclusion

Outline





5 Policy Relevance

6 Conclusion


Conclusion

Conclusion

Ricardo’s Legacy:

Economics as a science

Two of the three big ideas in international trade theory

Role of Theory

Don’t take exact predictions too seriously; conditional forecasts only

A lens through which to view the world ...

... and flush out bad ideas

Bad ideas?

Not Brexit per se (in economic terms at least)

Rather:

MercantilismAnti-GravityGlobal Britain


Conclusion

It’s the Science, Stupid!

March for Science, Saturday April 22, 2017


Conclusion

Thanks and Acknowledgements*

Thank you for listening. Comments welcome!

* Much of the author’s research on which this lecture draws has received funding from the European Research Council under theEuropean Union’s Seventh Framework Programme (FP7/2007-2013), ERC grant agreement no. 295669. The contents reflectonly the author’s views and not the views of the ERC or the European Commission, and the European Union is not liable for anyuse that may be made of the information contained therein.


Bibliography

Bibliography I

Autor, D. H., D. Dorn, and G. H. Hanson (2013): “The China Syndrome: LocalLabor Market Effects of Import Competition in the United States,” AmericanEconomic Review, 103(6), 2121–2168.

Bagwell, K., and R. W. Staiger (1999): “An Economic Theory of GATT,”American Economic Review, 89(1), 215–248.

Costinot, A. (2009): “An Elementary Theory of Comparative Advantage,”Econometrica, 77(4), 1165–1192.

Costinot, A., D. Donaldson, and I. Komunjer (2012): “What Goods DoCountries Trade? A Quantitative Exploration of Ricardo’s Ideas,” Review ofEconomic Studies, 79(2), 581–608.

Cowgill, B., and C. Dorobantu (2012): “Gravity and Borders in OnlineCommerce: Results from Google,” Working paper, university of oxford.

Dhingra, S., H. Huang, G. Ottaviano, J. Paulo Pessoa, T. Sampson, andJ. Van Reenen (2017): “The Costs and Benefits of Leaving the EU: Trade Effects,”Economic Policy, 32(92), 651–705.


Bibliography

Bibliography II

Dornbusch, R., S. Fischer, and P. A. Samuelson (1977): “ComparativeAdvantage, Trade, and Payments in a Ricardian Model with a Continuum of Goods,”American Economic Review, 67(5), 823–839.

Eaton, J., and S. Kortum (2002): “Technology, Geography, and Trade,”Econometrica, 70(5), 1741–1779.

Ethier, W. (1974): “Some of the Theorems of International Trade with Many Goodsand Factors,” Journal of International Economics, 4(2), 199–206.

Feenstra, R. C., and A. Sasahara (2017): “The China Shock, Exports and U.S.Employment: A Global Input-Output Analysis,” Working Paper 24022, NationalBureau of Economic Research.

Findlay, R. (1974): “Relative Prices, Growth and Trade in a Simple RicardianSystem,” Economica, 41(161), 1–13.

Head, K., and T. Mayer (2014): “Gravity Equations: Workhorse, Toolkit, andCookbook,” in G. Gopinath, E. Helpman, and K. Rogoff (eds.): Handbook ofInternational Economics, Vol. 4, Elsevier.

Keller, W., and S. R. Yeaple (2013): “The Gravity of Knowledge,” AmericanEconomic Review, 103(4), 1414–1444.


Bibliography

Bibliography III

Krugman, P. R. (1981): “Intraindustry Specialization and the Gains from Trade,”Journal of Political Economy, 89(5), 959–973.

Lendle, A., M. Olarreaga, S. Schropp, and P.-L. Vezina (2016): “There GoesGravity: eBay and the Death of Distance,” Economic Journal, 126(591), 406–441.

MacDougall, G. (1951): “British and American Exports: A Study Suggested by theTheory of Comparative Costs. Part I,” Economic Journal, 61(244), 697–724.

Maggi, G., M. Mrazova, and J. P. Neary (2017): “Choked by Red Tape? ThePolitical Economy of Wasteful Trade Barriers,” in preparation.

Maggi, G., and A. Rodrıguez-Clare (1998): “The Value of Trade Agreements inthe Presence of Political Pressures,” Journal of Political Economy, 106(3), 574–601.

Mrazova, M., and J. P. Neary (2017): “Not so Demanding: Demand Structureand Firm Behavior,” forthcoming in American Economic Review.

Portes, R., and H. Rey (2005): “The Determinants of Cross-Border Equity Flows,”Journal of International Economics, 65(2), 269–296.

Sampson, T. (2017): “Brexit: The Economics of International Disintegration,” Journalof Economic Perspectives, 31(4), 163–84.


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