emilyj.blanchard& research(statement...

Emily J. Blanchard Research Statement December 2017

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Recent decades have seen a fundamental shift in both the nature and distributional consequences of international trade. Rapid increases in cross-‐border investment and the advent of global production networks have transformed international commerce, creating new policy challenges. At the same time, technological advances and foreign competition are reshaping national labor markets, benefiting some workers and leaving others behind.

My research studies the economic and political consequences of these seismic changes in the global marketplace. As an applied theorist, I build models that balance simplicity with empirical relevance to identify the intended and unintended linkages between policy choices and international commerce. In complementary empirical work, I use my theory to guide estimation of the quantitative significance of these linkages in practice. My work is organized around two main questions. First, how are cross-‐border production and investment linkages changing the way firms and governments approach trade and trade policy? Second, to what extent does education distribute the benefits of globalization, and under what circumstances might it foster continued political support for trade? My theoretical work on cross-‐border production and investment takes a fresh look at the relationship between countries’ economic interests and trade barriers. I show that when firms’ operations and investors’ interests transcend national borders, they reshape governments’ trade policy interests as well. While the deeper economic linkages created by cross-‐border production and investment generally reduce countries’ incentives to manipulate tariffs, they can increase governments’ temptation to behave opportunistically using other (non-‐tariff) economic policies. Bringing theory to data, my work demonstrates that both multinational firms and global value chains are important drivers of trade policy in practice. Together, this research brings a deeper understanding of the role for trade agreements and the World Trade Organization (WTO) in the modern economy.

The second body of my research focuses on the political economy consequences of globalization. I study how individual heterogeneity and labor market frictions can lead to deep schisms in political interests across workers from different generations and with different levels of education. These divisions shape democratic political outcomes: continued support for globalization depends critically on whether or not workers are able to adjust to changing labor markets. My theoretical work addresses this question by examining how trade and trade policy affect educational attainment, and conversely how technology and human capital combine to determine attitudes toward trade policy. This research highlights education as a critical means to help workers adjust to changes in technology and trade, but it also shows that education spending is not a panacea: unless carefully targeted, subsidies or reforms to schooling may simply redistribute income toward those who are already at the top. My complementary empirical work demonstrates that trade has been an important driver of long run human capital accumulation in much of the world since the middle of the twentieth century.


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My research contributes both to the academic literature and to policy discourse. My contributions in economic theory offer a tool kit for future modeling work, while my empirical findings identify new avenues for further research. Translating research to practice, my work is gaining substantial traction in the policy community. Institutions including the WTO, the World Bank, the UN International Development Organization, think tanks, and government agencies in the United States and elsewhere are particularly interested in my work on cross-‐border production and investment, and have invited me to present these findings and collaborate in research.

The following pages describe my research in detail, organized around the two topics described above.

Trade and Policy Implications of Cross-‐border Production and Investment

This research agenda consists of two parts. The first evaluates the potential for cross-‐border production and investment to influence governments' preferences over trade barriers and related domestic commercial policies. The second explores the underlying linkages within and across firms that shape the pattern of cross-‐border supply chains.

Cross-‐border production and investment, including international supply networks or `global value chains’ (GVCs), are changing the way that firms interact with the global marketplace, and therefore the way that governments approach trade and regulatory policy. Production fragmentation and foreign investment forge “deep” economic linkages between countries and companies that muddy the distinction between domestic and foreign commercial interests. This evolution of economic borders changes both governments’ unilateral policy objectives and the potential role for trade agreements and institutions like the WTO.

My research takes up these issues using both theory and data. My theoretical approach starts with a simple observation: countries’ economic best interests are increasingly divorced from national borders. This reality stands in contrast to the prevailing trade policy literature in economics, which conventionally has adopted a national ownership setting with local production that implicitly rules out deeper economic linkages between countries. My work revisits these assumptions to study the influence first of cross-‐border investment (international ownership and foreign direct investment), and later of cross-‐border production (GVCs), on trade policy.

My article, “Reevaluating the Role of Trade Agreements: Does Investment Globalization Make the WTO Obsolete?” [Journal of International Economics, 2010] takes the broadest approach. Here I ask: what happens to the canonical understanding of trade agreements if we abandon the national ownership assumption? I take a deliberately broad view of “investment globalization,” developing a unifying theoretical structure that encompasses foreign direct investment, cross-‐border mergers and acquisitions, and international diversification of asset portfolios. I use theory to show that international ownership can induce large countries to lower their tariffs unilaterally.


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Intuitively, trade barriers like tariffs shift profits away from foreign exporters to domestic interests by improving a country’s terms of trade (increasing the world price of the country’s exports relative to its imports). Since international ownership causes domestic interests to internalize some of the negative “cost shifting” externality of tariffs, sufficient levels of foreign ownership may induce a government to cut its tariffs, even if its partners do not.

Based on this logic, I argue that greater international investment changes the role for the General Agreement on Tariffs and Trade (GATT), and its successor institution, the WTO in reaching globally efficient trading patterns. Building from the seminal work of Bagwell and Staiger (1999), I show that international ownership can overturn three existing tenets about the role of the GATT/WTO. Specifically, I demonstrate that (1) non-‐cooperative tariffs could be unilaterally efficient (which would render obsolete the WTO’s historical role as a mechanism to lower tariffs); (2) unilaterally optimal non-‐cooperative tariffs could in fact be too low (so that the role of the WTO could be reversed); and (3) international externalities may not be limited to the terms-‐of-‐trade for traded goods (which would introduce new roles for the WTO). These results are now part of standard teaching, and were afforded in-‐depth treatment in the most recent revision of the Handbook of Commercial Policy (2016). (In economics, these Handbooks serve as a set of “users guides” to the evolving frontier of academic research.)

The last point above provides a new economic rationale for expanding the WTO mandate to include “deep provisions” to limit behind the border policy manipulation, and for including small countries at the multilateral table (neither of which conventional models would justify). These are important insights for policy, which I address further in my article “A Shifting Mandate: International Ownership, Fragmentation, and a Case for Deeper Integration under the WTO.” [World Trade Review, 2015]

Pushing the ideas further, I explore the two-‐way causality between international investment and trade policy in “Foreign Direct Investment, Endogenous Tariffs, and Preferential Trade Agreements” [B.E. Journal – Advances, 2007]. Narrowing the focus to one particularly important form of international ownership, I study the simultaneous determination of trade policy and foreign direct investment (FDI) in a tractable general equilibrium setting. In the model, investment takes the form of profit-‐seeking physical flows of productive capital from an investment source country to one or many potential investment host countries. Consistent with my earlier work, I show that export-‐oriented foreign direct investment increases the incentives for an investment-‐source country to lower its tariffs, which would increase profits for its offshore capital owners. At the same time, lower tariff barriers will increase the flow of export-‐oriented FDI, which rises in response to higher profits. Export-‐oriented FDI and trade liberalization are thus reinforcing.

I then examine the potential for subsidy competition among potential FDI host countries. Extending the model to a multi-‐country setting, I allow countries to compete for investment by


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offering direct subsidies to foreign investors. The theory shows that even the possibility of preferential trade agreements can spur potential host countries to over-‐subsidize foreign direct investment. This mechanism can enhance global welfare if trade restrictions are initially too high, but if tariffs are already very low initially, the same liberalization cycle will lead to inefficiently too much trade and investment, reducing global welfare. The upshot is an important policy insight: the potential for preferential trade deals may pit potential FDI host countries against each other in a zero-‐sum race to attract foreign investment. In the model, every investment host country would be better off with stricter enforcement of GATT Article XXIV, which limits the scope for preferential trade deals. As far as I am aware, this paper is the first to formalize a two-‐way relationship between endogenous trade policy and outward foreign investment, and to offer a policy warning against preferential trade deals based on that link.

This paper attracted the attention of the WTO’s research division, which asked me to elaborate on these ideas as part of the 2014 World Trade Report. The resulting background paper, “What Global Fragmentation Means for the WTO,” [WTO Working Paper, 2014] explores the economic arguments for and against cooperative agreements to limit FDI subsidies.

Lerner Symmetry is one of the most sacrosanct results in neo-‐classical trade theory. It provides the theoretical foundation for the idea that only relative goods prices matter, so that import tariffs are equivalent to export taxes. My research shows that adding international ownership to an otherwise standard trade model will almost always upset Lerner Symmetry. My article “Trade Taxes and International Investment” [Canadian Journal of Economics, 2009] proves this result formally and traces out the implications for modeling trade and investment policies. The paper thus offers a handbook for how to conduct formal analysis of trade taxes with cross-‐border ownership. Subsequently, this paper has received renewed attention in the debate over a possible Border Adjustment Tax (BAT), which has been proposed by House Republicans as part of a corporate tax overhaul. Whereas Lerner Symmetry would imply that a BAT would be offset by exchange rate adjustments (which implicitly suggests that the BAT may be innocuous under flexible exchange rates), my results indicate that the same result may not obtain in the presence of international investment absent additional conditions.

Together, the preceding papers develop a compact set of theoretical results with direct policy implications. In complementary empirical work, I bring theory to data and demonstrate that these mechanisms are important in practice.

My article “US Multinationals and Preferential Trade Agreements,” [with X. Matschke, Review of Economics and Statistics, 2015] explores whether US trade policy responds to the overseas interests of US multinational firms. Theory predicts that all else equal, the US government will have stronger incentives to improve market access (lower tariffs) for countries and industries when US multinational firms stand to share in the gains. A key challenge in this empirical work is that multinational firms’ activities are endogenous, and depend in part on US trade policy. We


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use instrumental variables to address this endogeneity, leveraging detailed data on worldwide sales of goods and services by foreign affiliates of US multinational firms, which I obtained as a special sworn employee of the Bureau of Economic Analysis. We find strong evidence of a causal link: US trade preferences accrue disproportionately in favor of US multinational firms’ affiliates. Moreover, this effect is strongest for preferences under the Generalized System of Preferences (GSP), the principal aid-‐through-‐trade program in the US. We complement our formal empirical analysis with an overview of public-‐record tariff petitions to reveal how multinational firms lobby for preferential tariff access in practice. We thus shed light not only on observed policy outcomes, but also on the formal institutional features that underlie the patterns we see in the data.

This project impressed on me the importance of a deep working knowledge of policy institutions when conducting empirical work on trade and trade policy. It also exposed a near-‐total absence of academic research on how the Generalized System of Preferences operates in practice. My article “The US Generalized System of Preferences: In Principle and Practice” [with S. Hakobyan, World Economy, 2015] addresses this gap in the literature. In this paper, my co-‐author and I carefully document the extent and sources of unilateral discretion exercised by the US government in shaping its GSP, aid-‐through-‐trade tariff preferences. We combine hand-‐collected data on GSP petitions and outcomes, documentation of the relevant trade law, and an overview of the institutional procedures used to determine GSP preferences in practice. The result is a valuable resource for researchers. Although it is a descriptive contribution, this article’s importance is reflected in the Handbook of Commercial Policy (2016), which cited it in multiple chapters.

In recent research, I have shifted focus to explore the related question of how cross-‐border production affects trade policy, separate from international ownership. The first paper to come out of this work, “Global Value Chains and Trade Policy,” [with R. Johnson and C. Bown, working paper, 2017] tackles a difficult theoretical question: how to study the effects of cross-‐border production on trade policy when it takes so many forms in practice. Global value chains (GVCs) encompass intra-‐firm trade and arms-‐length sales, specialized input trade and market transactions of commoditized intermediates, and everything from sequential to simultaneous supply-‐chain production. Our key innovation in this paper is to introduce a new ``value added approach,’’ which allows us to measure the impact of GVCs in a unified framework. In developing the theoretical foundations for this approach, this paper extends my earlier work to show that GVCs can be summarized by a combination of empirically measurable value-‐added flows and a set of pass-‐through elasticities that can be recovered from data. Bringing theory to data, we show that both domestic value added embodied in foreign production, and foreign value added embodied in domestic production induces governments to lower their bilateral tariffs. In a separate exercise with data on temporary trade barriers, we confirm our findings for tariffs and show that GVCs are particularly important in shaping the use of (especially) anti-‐dumping duties


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against China. The upshot is that governments systematically curb their protectionist motivations when domestic interests are bound up with foreign exporters via GVC linkages.

My work on GVCs and trade policy has generated significant attention beyond academic circles. Business and policy questions surrounding global production and investment have stormed the front page of national newspapers like the Washington Post, New York Times, Financial Times, The Economist, Wall Street Journal, etc., whose journalists now regularly use our value added language (and frequently quote our calculations) in economics reporting. My co-‐authors and I are playing an active behind-‐the-‐scenes role in this journalism, helping to clarify and elevate the quality of reporting on these GVC linkages in today’s trade policy environment. Applying research to practice directly, I have contributed analysis for the World Bank, Canada’s Institute for Research on Public Policy (IRPP), and the Center for Economic Policy Research (CEPR), among others. (“Trade Policy, Latin America, and Value Chains;” [with C. Bown and R. Johnson, working paper] “Leveraging Global Supply Chains in Canadian Trade Policy;” [IRPP Press, 2015; 2017] and “Renegotiating NAFTA: The Role of Global Supply Chains” [CEPR Press, 2017])

This research demonstrates that GVCs are critically important drivers of trade and trade policy, but where do they come from? In recent work, I have begun to unpack the production fragmentation phenomenon by looking more closely at trading firms’ decisions over sourcing and exporting. This research builds on the idea that increasingly complex global production networks challenge the conventional understanding of both what it means to be an exporting firm, and how firms in one country reach consumers in another.

My article “Carry-‐Along Trade” [with A. Bernard, I. VanBeveren, and H. Vandebussche, Review of Economic Studies, forthcoming] uncovers a surprising new fact: the overwhelming majority of manufacturing firms export products that they do not make. Using detailed product-‐firm level data from Belgium, my co-‐authors and I show that three quarters of exported products and thirty percent of export value from Belgian manufacturers are in goods that are not produced by the firm. Systematically, it is the largest and most productive firms that engage most in this “Carry-‐Along Trade’’. We propose a new model to explain this phenomenon, in which multi-‐product manufacturing firms face a ‘make or source’ decision. Our approach in the theory is deliberately agnostic as we pry open the black box of firm behavior. Using the theory, we identify a set of demand-‐ and supply-‐side mechanisms that are capable of explaining the patterns observed in the data, which we explore with subsequent empirical exercises. The data offer particular support for a new theoretical explanation: demand-‐scope complementarities, based on the idea that consumers may demand “bundles” of complementary products, some of which a manufacturer produces, and others that the manufacturer can source via Carry-‐Along Trade.

These findings carry a number of important implications. For instance, if a firm’s ability to successfully serve consumers hinges on its ability to provide a comprehensive bundle of goods, then firms in small or developing countries with limited access to suppliers may struggle to serve


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consumers. At the same time, the prevalence of Carry-‐Along Trade suggests that manufacturing firms may serve as previously unrecognized conduits by which global trade shocks are propagated more or less directly through (unobserved) local supply networks via Carry-‐Along Trade.

Finally, my article, “Private Label Exports: Trading Variety for Volume” [with T. Chesnokova and G. Willmann, Review of World Economics, 2017] considers the flipside of the make or source margin, studying the decisions of independent exporters to reach consumers directly or via intermediary firms. The paper asks whether large retail trade intermediaries (Wal-‐Mart, for example) are only an efficient new way to bring products to market or whether they also distort trade flows at the cost of exporters and consumers. (The answer is both.) Developing a heterogeneous firms model, we find that the presence of multinational trade intermediaries can change the variety, volume, and prices of traded products available to consumers. We show that ‘private labels’, which allow intermediary firms to pool products under a single umbrella brand, introduce a trade-‐off between variety and volume, and can reduce welfare for both upstream exporters and consumers. The immediate implication is that the welfare impact of trade intermediaries may not be as simple as suggested elsewhere in the literature.

Trade, Education, and Political Support for Globalization

My second research agenda focuses on the interaction between globalization, education, and political support for trade. Rising import competition and (especially) technological change are polarizing local labor markets and increasing income inequality in much of the developed world. I explore the political implications of this phenomenon, focusing on the question of how education and technology combine to determine attitudes toward trade policy, and at the same time, how democratic choices over trade policy affect educational attainment. This research highlights the interaction between political and economic outcomes, consistent with the emphatic call by leading scholars Daron Acemoglu and James Robinson [Journal of Economic Perspectives, 2013] to advance the research frontier on political-‐economic feedback loops.

My article “Escaping a Protectionist Rut: Policy Mechanisms for Trade Reform under Democracy” [with G. Willmann, Journal of International Economics, 2010] evaluates the role of workers’ expectations over future trade policy in determining individual schooling decisions and voting behavior. We develop a theoretical model to demonstrate the potential for rational voters to maintain status quo protection against imports, even when the majority of citizens could be made better off through tariff reform. Intuitively, when individuals’ educational investments are ‘sunk’, older voters’ behavior will reflect past expectations. This timing leads to self-‐fulfilling (political) prophecy: if workers expect trade protection against low-‐skill imports in the future, they will acquire fewer skills in the interim. This less-‐educated population will then in turn become a protectionist political majority in the future. We study a set of potential mechanisms including educational reforms, to ask how democracies can avoid the potential for ‘protectionist


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ruts’. Key results include both the potential for multiple equilibria with self-‐fulfilling expectations and the potential for education policy to “break” bad equilibria. Comparing these results to basic mechanisms of the Trade Adjustment Assistance program in the US, we argue in favor of education subsidies over lump-‐sum compensation.

These results pose a puzzle: if education is a silver bullet for helping workers to adjust to trade in developing countries, then why have so many recent empirical studies documented increasing polarization of skills and income in Europe, the UK, and the US? My article “Trade, Education, and the Shrinking Middle Class” [with G. Willmann, Journal of International Economics, 2016] takes up this question by building a tractable assignment model that is consistent with recent empirical evidence. In the model, trade can induce some workers to move up the skill acquisition ladder, while others sort down. This framework addresses a shortcoming in the literature by developing a new workhorse trade model in which non-‐monotonic responses to trade are possible. Using this model, we then explore potential remedial policy actions to protect middle class workers who may be threatened by import competition. We demonstrate that targeted education subsidies are better than trade protection for bolstering the middle class, but are far from a panacea. Unless educational subsidies are large enough to boost workers over potentially distant rungs of the education ladder, they will simply redistribute income toward those already at the top.

I explore the empirical link between trade and educational attainment in “Globalization and Human Capital Investment: How Export Composition Drives Educational Attainment” [with W. Olney, Journal of International Economics, 2017] Building from my theory, we examine whether the skill composition of a country’s exports has differential effects on educational attainment along the educational ladder. Endogeneity is a key challenge in this work, since trade patterns are shaped by countries’ endowments. We devise a new gravity-‐based instrumental variables technique to address this concern, using exogenous shocks in a country’s trading partners to predict bilateral trade flows for different kinds of goods, and thus the overall composition of a country’s exports. Using cross-‐country panel data for fifty years and more than a hundred countries, we find that changes in the skill-‐composition of a country’s exports are important determinants of subsequent aggregate educational attainment. The data suggest that greater exports of low-‐skill manufactured goods or agricultural goods reduce educational attainment at the primary or secondary levels, while greater exports of high-‐skill manufactured goods increase educational attainment, particularly at the higher educational levels. These effects are strongest among developing countries. These results are encouraging for some countries and sobering for others: while countries that export predominantly skill-‐intensive goods can expect education to continue to rise, the less-‐developed countries that specialize in low-‐skill intensive goods may fall further behind the rest of world in terms of educational attainment.

A related paper, “Opening (and Closing) Doors: Country Specific Shocks in U.S. Doctorate Education” [with J. Bound and S. Turner, Cornell University Press, 2008], explores the relationship


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between openness and education at the very top of the education ladder by documenting the drivers of US doctorate attainment by international students. Together, these empirical results on the interaction between education and globalization offer clear evidence that openness has important short-‐ and long-‐run effects on human capital accumulation.

Finally, my new paper “Unequal Gains, Prolonged Pain: A Model of Protectionist Overshooting and Escalation” [with G. Willmann, working paper] focuses on long and short run economic and political responses macroeconomic shocks. Building an overlapping generations model with both `sticky’ labor market adjustment and endogenous economic inequality, we show that when political change can happen faster than economic adjustment, and when the distribution of human capital is concentrated at the top, an unanticipated trade shock or skill-‐biased technological change can result in a surge of popular support for protectionism. In a democracy, the result will be a spike in tariffs that blunts the incentives for future generations to invest in education. These distortionary effects can persist long after a shock is realized, reducing aggregate welfare over long time horizons. We show that the long-‐run consequences depend not on overall education levels, but on whether or not less-‐skilled workers are eventually able to catch up to the overall economy. If convergence is possible, the short run tariff spike will gradually unwind, as workers increase education and support for freer trade rises. Alternatively, if education allows the top earners to continue pulling ahead of the majority, the result will be a pendulous transition to permanently higher tariffs. We use the model to construct a set of criteria for evaluating the likely political implications of education and redistribution policies, and we present data on economic mobility and income inequality, which indicate that the US and UK are outliers relative to other OECD countries.

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