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Brookings Trade Forum 2003

Brookings Trade Forum 2003

by Susan M. Collins (Editor), Dani Rodrik (Editor)

This annual series provides comprehensive analysis on current and emerging issues of international trade and economics. In this volume, researchers use theory and empirics to provide novel analyses of six of the key issues surrounding the integration of developing countries into the global market place. Contents include: Trade Policy and Industrial Sector


This annual series provides comprehensive analysis on current and emerging issues of international trade and economics. In this volume, researchers use theory and empirics to provide novel analyses of six of the key issues surrounding the integration of developing countries into the global market place. Contents include: Trade Policy and Industrial Sector Responses in the Developing World: Interpreting the Evidence Erkan Erdem and James Tybout (Pennsylvania State University) Globalization's Impact on Compliance with Labor Standards Ann Harrison and Jason Scorse (University of California, Berkeley) When Economic Reform Goes Wrong: Cashews in Mozambique Margaret McMillan (Tufts University), Dani Rodrik (Harvard University), and Karen Horn Welch (Stanford University) Staying The Course: Maintaining Fiscal Control In Developing Countries Christopher Adam and David Bevan (Oxford University) Through What Channels Does External Debt Affect Growth? Catherine Pattillo, Helene Poirson, and Luca Ricci (International Monetary Fund) Crisis Resolution: Next Steps Barry Eichengreen (University of California, Berkeley), Kenneth Kletzer (University of California, Santa Cruz), and Ashoka Mody (International Monetary Fund)

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Brookings Institution Press
Publication date:
Brookings Trade Forum Series
Edition description:
New Edition
Product dimensions:
6.00(w) x 8.90(h) x 0.90(d)

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Brookings Trade Forum 2003

Brookings Institution Press

Copyright © 2003 Brookings Institution Press
All right reserved.

ISBN: 0-8157-1287-1

Chapter One


Editors' Summary

The Brookings Trade Forum held its sixth annual conference in Washington on May 15-16, 2003. This volume contains the papers, invited commentary, and general discussions from that conference.

The volume's first three papers focus on implications of heightened foreign competition, as developing countries increase their exposure to the global market. The first paper uses a dynamic simulation model to better understand the interrelated channels through which trade liberalization affects the efficiency of domestic firms. The second paper tackles a novel aspect of globalization's impact on labor standards, empirically examining effects of foreign pressures on compliance with minimum wage laws in Indonesia. The third undertakes a detailed case study of the controversial economic reform of the cashew sector in Mozambique, estimating gains and losses incurred and drawing broader lessons for liberalization.

The remaining three papers address macroeconomic topics. One undertakes a broad empirical analysis of when countries are able to sustain fiscal consolidation. It finds clear differences in experience across low-, middle-, and high-income country groups. Another empirically examines the linkages between external debt and economic growth, finding high-debt stocks to have particularly deleterious implications for both capital accumulation and productivity. The volume's final paper uses both theory and empirics to evaluate the efficacy of introducing collective action clauses into bond contracts, a recent approach intended to address the persistent problem of sovereign debt crises.

In the first paper Erkan Erdem and James Tybout take a new look at whether trade liberalization really does tend to increase manufacturing efficiency in developing countries. Over the past two decades, a substantial body of evidence has accumulated on the firm- and plant-level effects of openness in developing countries, including influential earlier work by Tybout. This literature has generated findings, now typically accepted as stylized facts, about how increased foreign competition acts to discipline domestic firms. Import discipline is believed to work primarily through two channels. First, it squeezes price-cost margins among import-competing firms. This heightened competitive pressure induces productivity gains among these same firms. Second, additional efficiency gains are expected to come from reallocations of firms' market shares.

Erdem and Tybout argue that although these findings are useful, they leave many central issues unresolved and may be misleading because they tell only part of the story. Their paper highlights concerns that arise from problems with the way in which firm-level productivity has been measured in the literature. It also emphasizes additional dimensions of firm-level responses and recognizes that these may become increasingly important over time. Taking a more nuanced perspective, the effects of trade liberalization may be quite different in the short run than the long run.

The objective of the Erdem and Tybout paper is to begin to address these shortcomings. The authors' approach is to develop a computable model of industrial evolution that enables them to simulate the effects of import competition as they unfold over time. They are able to demonstrate what types of managerial behavior, long-term transition paths, and welfare effects are consistent with the findings of previous firm- and plant-level empirical studies. The model also provides a rigorous means to evaluate the combined effects of various forces.

Erdem and Tybout's paper begins with a brief overview of the logic behind the import discipline hypothesis. It then surveys the empirical evidence supporting this hypothesis, focusing on analyses of five natural experiments. Particularly informative is the table summarizing results from studies of liberalization in Chile, Mexico, Côte d'Ivoire, Brazil, and India. As this survey shows, these studies are consistently supportive of the hypothesis that trade liberalization increases productivity.

The authors then explain why problems in how productivity is measured may induce biases in both the cross-section and time-series variation in efficiency gains across firms. Primarily because of data limitations, empirical productivity studies measure output as deflated revenues and intermediate inputs as deflated expenditures. Neither of these reflects the considerable heterogeneity in both outputs and inputs across firms. Thus in addition to productivity, these measures will reflect other factors such as degree of market power and output demand elasticities. To take one example, the authors note that big firms tend to pay workers more and face relatively low demand elasticity and appear relatively efficient using these indicators. This bias would tend to cause measured efficiency gains to be overstated if market share shifts toward large firms following trade liberalization. But other types of biases may work in the opposite direction. The authors also note that measures of productivity typically omit costs of firm innovation and costs of work force downsizing. These omissions imply that they tend to overstate the gains from liberalization.

Even if ideal measures of firm productivity were available, Erdem and Tybout stress that the existing literature is only partially informative because it does not distinguish the mechanisms through which import competition affects firms' efficiency. In this regard, they identify three specific weaknesses of past empirical work. First, it fails to characterize the managerial behavior behind the efficiency gains. Second, it only describes the short-run effects of trade liberalization. And third, it does not translate firms' performances into welfare measures.

The structural features of their model are developed so as to enable the authors to address these shortcomings. Specifically, their model, which allows for imperfect competition, has dynamic, forward-looking, and heterogeneous domestic firms. Entry and market share reallocation are endogenous. Microfoundations are specified for a form of induced innovation, and there are costs to both entry and innovation. The resulting model is rich but complex. Thus the authors consider only a small number of domestic firms-at most six, but typically only three to five.

Simulations of their model illustrate both the expected short-run adjustment from import discipline and the more nuanced intraindustry adjustments that have typically been omitted. In terms of the former, their results show trade liberalization reducing price-cost margins and raising efficiency, largely because inefficient firms exit and weak product lines are discontinued. But interestingly, they find that productivity gains due to the purging of weak firms are transitory, and likely to dissipate within ten to fifteen years of trade liberalization.

As the purging effects fade, the simulations find that the cumulative effects of reform-induced changes in the incentive to innovate become more important. However, these innovation effects are often negative. Foreign competition can create a longer-term tendency for the quality of domestic goods to deteriorate relative to imports. Depending on the nature of the trade reforms, this tendency may or may not be offset by quality or efficiency gains due to embodied technological progress in imported capital. In any case, the simulations show that heightened import competition is likely to be accompanied by permanently higher plant or product line turnover, combined with more rapid job creation and destruction. Finally, the results suggest quite strong welfare implications. Specifically, there is a strong possibility of welfare losses on the part of domestic producers. In contrast, incorporating the additional dimensions of potential firm-level response suggests somewhat larger welfare gains among consumers, due to lower prices.

Discussants and conference participants very positively received the basic theoretical approach and particular results reported in the paper. However, there was some discussion of the robustness of the results, and the trade-off between model tractability and generality.

MOTIVATED BY THE LARGER QUESTION of the implications of globalization for labor standards in developing economies, the paper by Ann Harrison and Jason Scorse analyzes compliance with minimum wage legislation in Indonesia, using panel data on manufacturing plants. Indonesia's experience is a particularly interesting one to study for a number of reasons. The government made minimum wages a central component of its labor market policies in the 1990s. These wage minimums differ significantly across regions as well as over time. Over the past decade, minimum wages quadrupled in nominal terms, and doubled in real terms. At the same time the real value of the minimum wage surged, Indonesia's entry into international markets increased dramatically. In addition, Indonesia became a primary target of international human rights groups, with Nike's footwear factories emerging as poster children in the global campaign against sweatshops.

Harrison and Scorse introduce their study by discussing the key points made by those who argue that the competitive pressure imposed by international competition is likely to create a "race to the bottom" in global labor standards. These antiglobalization forces frequently claim that competition induced by globalization leads firms to ignore or fail to comply with labor standards so as to reduce costs. Exporters that face either international markets or foreign competitors in the home market, as well as multinationals faced with cheap imitators from low-wage regions, may attempt to cut costs by paying lower wages, hiring child labor, and imposing unsanitary working conditions on workers.

From this perspective, globalization is likely to undermine national efforts to impose labor standards. Even if countries are successful in passing legislation that introduces (or raises) labor standards, global pressures may prevent firms from adhering to them. This is likely to be the case when penalties for noncompliance are low. Under such circumstances, labor standard legislation, such as minimum wage laws, may simply be viewed as a useful but nonbinding guideline for wage-setting activities.

On the other hand, the authors stress that increasing political activity by human rights organizations has focused greater scrutiny on the behavior of exporting firms and large multinationals. These types of firms are increasingly being held to high standards. While there are no clear international penalties for deviation from local labor legislation, the reputational effects are potentially significant, as enterprises like Nike have learned.

In their analysis, Harrison and Scorse estimate the relationship between international competition and compliance with the statutory minimum wage in Indonesia. They use two plant-level indicators to identify firms facing international competition: the plant's export orientation and whether or not the plant is foreign owned. This framework provides a direct test of the relationship between measures of globalization and labor standards, as defined by compliance with the regional minimum wage.

They find positive relationships between compliance with labor standards and outward orientation, both measured by export sales and foreign ownership. They begin with a description of the broad trends during the 1990s, which suggest that both multinationals and exporting firms are more likely to comply with labor standards. These differences are borne out by simple statistical tests, which show that foreign and exporting enterprises are both more likely than domestic nonexporters to comply with minimum wage legislation.

However, once the authors add controls for capital intensity and technical change, the differences in compliance probabilities between foreign plants and other enterprises are cut in half, and the likelihood of compliance for exporters switches from positive to negative. They find that at the beginning of the 1990s, exporters were significantly less likely to adhere to minimum wage laws compared to other similar plants. The characteristics most strongly associated with increased minimum wage compliance are greater capital intensity and higher investment in machinery. This result is not surprising, given that firms with these characteristics are likely to pay higher wages.

One of their most interesting findings is a significant upward trend in compliance with minimum wage legislation for exporting enterprises during the 1990s. Their estimates imply that the probability of compliance with minimum wage legislation increased for exporting firms by about 3 percent a year. Harrison and Scorse hypothesize that this upward trend is connected with pressure from the U.S. and European governments, human rights activists, and news coverage. Beginning in the 1990s, North American and European Union groups expressed concern about Indonesian exporters and the labor market conditions of their workers, particularly in exporting sectors. Complaints by U.S. groups were filed first in 1987 and then again in 1992, citing violation of worker rights under the Generalized System of Preferences (GSP). In response the Indonesian government made a number of policy changes in its minimum wage laws in the 1990s. Thus the authors conclude that their analysis suggests the Indonesian government was successful in raising compliance with the minimum wage, at least in exporting sectors that were the focus of U.S. and European criticism.

Harrison and Scorse find that these trends are even more striking in the garment and apparel industry, which has been the main focus of human rights groups. The authors argue that this result suggests that human rights activism, in fact, has had an impact on firm behavior. And contrary to frequently voiced expectations, their results for Indonesia suggest that forcing firms to adhere to higher labor standards need not have adverse consequences for employment.

More generally, the authors conclude that their paper's analysis of the Indonesian experience refutes the claim that pressures to compete in the global market place are creating a race to the bottom. The evidence for Indonesia in the 1990s suggests that firms touched by the global market place were more, not less, likely to comply with labor standards. Furthermore, compliance increased despite a doubling of the real value of the minimum wage in Indonesia during this period, enormous increases in foreign investment and export sales, and a painful currency crisis that erupted in late 1997.


Excerpted from Brookings Trade Forum 2003 Copyright © 2003 by Brookings Institution Press . Excerpted by permission.
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Meet the Author

Susan M. Collins is a senior fellow in Economic Studies at the Brookings Institution and a professor of economics at Georgetown University. Her publications focus on various dimensions of economic policy and performance for developing countries. Dani Rodrik is professor of international political economy at the John F. Kennedy School of Government, Harvard University. He has published widely on issues related to trade policy and economic reform in developing economies, including Has Globalization Gone Too Far? (Institute for International Economics, 1997) and The New Global Economy and Developing Countries: Making Openness Work (Overseas Development Council, 1999).

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