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Handbook of International Economics
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Handbook of International
Economics
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Handbook of International
Economics
4 VOLUME
Edited by
GITA GOPINATH
Harvard University, Cambridge, MA, USA
National Bureau of Economic Research, Cambridge, MA, USA
ELHANAN HELPMAN
Harvard University, Cambridge, MA, USA
Canadian Institute for Advanced Research
National Bureau of Economic Research, Cambridge, MA, USA
KENNETH ROGOFF
Harvard University, Cambridge, MA, USA
National Bureau of Economic Research, Cambridge, MA, USA
North-Holland is an imprint of Elsevier
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herein. Because of rapid advances in the medical sciences, in particular, independent
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British Library Cataloguing in Publication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging-in-Publication Data
A catalog record for this book is available from the Library of Congress
ISBN–13: 978-0-444-54314-1
For information on all North-Holland publications
visit our website at http://store.elsevier.com/
Printed and bound in Poland
14 15 16 17 18 10 9 8 7 6 5 4 3 2 1
v
Contributors ix
Introduction to the series xi
Preface xiii
1. Heterogeneous Firms and Trade 1
Marc J. Melitz and Stephen J. Redding
1. Introduction 1
2. Empirical Evidence 2
3. General Setup 4
4. Closed Economy Equilibrium 10
5. Open Economy with Trade Costs 12
6. Quantitative Predictions 24
7. Factor Abundance and Heterogeneity 32
8. Trade and Market Size 33
9. Endogenous Firm Productivity 37
10. Factor Markets 46
11. Conclusion 48
References 49
2. Multinational Firms and the Structure of International Trade 55
Pol Antràs and Stephen R. Yeaple
1. Introduction 55
2. Stylized Facts 59
3. Benchmark Model: An Extended Krugman (1980) Model 66
4. The Proximity-Concentration Hypothesis 68
5. Vertical Expansion 85
6. Multicountry Models 96
7. Multinational Firm Boundaries 102
8. Conclusion 125
References 126
3. Gravity Equations: Workhorse, Toolkit, and Cookbook 131
Keith Head and Thierry Mayer
1. Introduction 132
2. Micro-Foundations for Gravity Equations 137
3. Theory-Consistent Estimation 150
4. Gravity Estimates of Policy Impacts 160
CONTENTS
vi Contents
5. Frontiers of Gravity Research 172
6. Directions for Future Research 189
7. Conclusion 190
References 190
4. Trade Theory with Numbers: Quantifying the Consequences
of Globalization 197
Arnaud Costinot and Andrés Rodríguez-Clare
1. Introduction 197
2. Getting Started 200
3. Beyond Armington 205
4. Evaluating Trade Policy 225
5. Numbers We Can Believe In? 236
6. "Micro" versus "Macro" Numbers 248
7. Life without Gravity 253
8. Concluding Remarks 256
References 257
5. Domestic Institutions as a Source of Comparative Advantage 263
Nathan Nunn and Daniel Trefler
1. Introduction 263
2. Contracting and Property-Right Institutions: Impacts on Comparative Advantage 265
3. Informal Institutions and their Impacts on Comparative Advantage 288
4. Policies and the Indirect Impacts of Institutions on Comparative Advantage 299
5. The Impact of Trade and Comparative Advantage on Domestic Institutions 300
6. Conclusion 309
References 309
6. International Trade Agreements 317
Giovanni Maggi
1. Introduction 317
2. The Motives for Trade Agreements 319
3. The Design of Trade Agreements 346
4. Regional Trade Agreements 369
5. Conclusion 383
References 384
7. International Prices and Exchange Rates 391
Ariel Burstein and Gita Gopinath
1. Introduction 391
2. Empirical Evidence 393
Contents vii
3. A Simple Framework to Interpret Empirical Findings 412
4. Models with Desired Variable Markups 426
5. Other Models of Incomplete Pass-through 431
6. Industry Equilibrium 435
7. General Equilibrium 437
8. Conclusion 442
9. Appendix 443
References 447
8. Exchange Rates and Interest Parity 453
Charles Engel
1. Exchange Rates and Interest Parity 453
2. Monetary Sticky-Price Models of Exchange Rates 456
3. Empirical Studies of Exchange Rates 469
4. Ex Ante Excess Returns and the Uncovered
Interest Parity Puzzle 494
5. Conclusions 515
References 516
9. Assessing International Efficiency 523
Jonathan Heathcote and Fabrizio Perri
1. Introduction 523
2. A Methodology for Assessing International Efficiency 524
3. Assessing Long-Run Efficiency 528
4. Assessing Efficiency in International Business Cycles 549
5. Conclusion 579
6. Appendix: Proof of Proposition 1 580
References 582
10. External Adjustment, Global Imbalances, Valuation Effects 585
Pierre-Olivier Gourinchas and Hélène Rey
1. Introduction 585
2. Stylized Facts 588
3. Long-Term Capital Flows in the Neoclassical Growth Model 596
4. Models of Global Imbalances 604
5. External Balance Sheets, Valuation Effects, and Adjustment 622
6. The International Monetary and Financial System 638
7. Conclusion 640
References 640
viii Contents
11. Sovereign Debt 647
Mark Aguiar and Manuel Amador
1. Introduction: Conceptual Issues 647
2. Empirical Facts 649
3. A Benchmark Framework 652
4. Richer Notions of "Default" 667
5. Self-Fulfilling Debt Crises 672
6. Incomplete-Market Models and their Quantitative Implementation 676
7. Concluding Remarks 683
References 684
12. International Financial Crises 689
Guido Lorenzoni
1. Introduction 689
2. Fiscal-Monetary Imbalances 691
3. Overvaluation, Unemployment, and Multiple Equilibria 696
4. Financial Flows, Sudden Stops, and Balance Sheet Effects 709
5. Spread Spirals and Rollover Crises 716
6. Sources of Fragility 723
7. Concluding Remarks 736
References 736
Index 741
ix
Mark Aguiar
Princeton University, Princeton, NJ, USA
Manuel Amador
Federal Reserve Bank of Minneapolis, Minneapolis, MN, USA
Pol Antràs
Harvard University, Cambridge, MA, USA
National Bureau of Economic Research, Cambridge, MA, USA
Centre for Economic Policy Research, London, UK
Ariel Burstein
University of California, Los Angeles, CA, USA
National Bureau of Economic Research, Cambridge, MA, USA
Arnaud Costinot
Massachusetts Institute of Technology, Cambridge, MA, USA
National Bureau of Economic Research, Cambridge, MA, USA
Charles Engel
University of Wisconsin, Madison, WI, USA
National Bureau of Economic Research, Cambridge, MA, USA
Gita Gopinath
Harvard University, Cambridge, MA, USA
National Bureau of Economic Research, Cambridge, MA, USA
Pierre-Olivier Gourinchas
University of California, Berkeley, CA, USA
National Bureau of Economic Research, Cambridge, MA, USA
Centre for Economic Policy Research, London, UK
Keith Head
Sauder School of Business, University of British Columbia, Canada
Centre for Economic Policy Research, London, UK
Jonathan Heathcote
Federal Reserve Bank of Minneapolis, Minneapolis, MN, USA
Centre for Economic Policy Research, London, UK
Guido Lorenzoni
Northwestern University, Evanston, IL, USA
National Bureau of Economic Research, Cambridge, MA, USA
CONTRIBUTORS
x Contributors
Giovanni Maggi
Yale University, New Haven, CT, USA
Graduate School of Economics, Getulio Vargas Foundation, Brasil
National Bureau of Economic Research, Cambridge, MA, USA
Thierry Mayer
Sciences-Po, Paris, France
Centre d'études prospectives et d'informations internationales, France
Centre for Economic Policy Research, London, UK
Marc J. Melitz
Harvard University, Cambridge, MA, USA
National Bureau of Economic Research, Cambridge, MA, USA
Centre for Economic Policy Research, London, UK
Nathan Nunn
Harvard University, Cambridge, MA, USA
National Bureau of Economic Research, Cambridge, MA, USA
Fabrizio Perri
Federal Reserve Bank of Minneapolis, Minneapolis, MN, USA
National Bureau of Economic Research, Cambridge, MA, USA
Centre for Economic Policy Research, London, UK
Stephen J. Redding
Princeton University, Princeton, NJ, USA
National Bureau of Economic Research, Cambridge, MA, USA
Centre for Economic Policy Research, London, UK
Hélène Rey
London Business School, London, UK
National Bureau of Economic Research, Cambridge, MA, USA
Centre for Economic Policy Research, London, UK
Daniel Trefler
University of Toronto, Toronto, ON, Canada
National Bureau of Economic Research, Cambridge, MA, USA
Andrés Rodríguez-Clare
University of California, Berkeley, CA, USA
National Bureau of Economic Research, Cambridge, MA, USA
Stephen R. Yeaple
Pennsylvania State University, University Park, PA, USA
National Bureau of Economic Research, Cambridge, MA, USA
xi
The aim of the Handbooks in Economics series is to produce Handbooks for various
branches of economics, each of which is a definitive source, reference, and teaching
supplement for use by professional researchers and advanced graduate students. Each
Handbook provides self-contained surveys of the current state of a branch of economics
in the form of chapters prepared by leading specialists on various aspects of this branch
of economics. These surveys summarize not only received results but also newer developments, from recent journal articles and discussion papers. Some original material is
also included, but the main goal is to provide comprehensive and accessible surveys. The
Handbooks are intended to provide not only useful reference volumes for professional
collections but also possible supplementary readings for advanced courses for graduate
students in economics.
Kenneth J. Arrow and Michael D. Intriligator
INTRODUCTION TO THE SERIES
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xiii
Almost twenty years have passed since the publication of Volume 3 of the Handbook
of International Economics in 1995. Much has changed since then, both in international
trade and international macroeconomics. The changes are fourfold: (a) new questions
have arisen as the world trade and payment system has evolved; (b) new data sets have
become available; (c) new theoretical models have been designed to address new issues,
but they have also enabled sharper and deeper analyses of older issues; and (d) new
empirical studies have greatly enriched our understanding of the global economy.
The chapters in this handbook review, illuminate, and interpret these developments
in a systematic way, making this material—which is technical at times—accessible to
professional economists and graduate students alike. Trade is covered in the first six
chapters, and international macroeconomics is covered in the subsequent six chapters.
1. INTERNATIONAL TRADE
Neoclassical analysis of foreign trade focused on comparative advantage at the sectoral
level, be it due to variation in productivity or factor endowments. Firms as suppliers of
unique brands of differentiated products and monopolistic competition were integrated
into trade theory in the 1980s (see Krugman 1995 for a review). Yet as much as these
improvements have been important, they focused on sectoral outcomes by treating
firms within industries as symmetric entities. Given the aim of that research, which was
to expand the neoclassical framework to accommodate intraindustry trade and large
volumes of trade between similar countries, the symmetry assumption was a reasonable
simplification. Except that it proved to be inadequate for interpreting evidence that
emerged in the 1990s concerning the participation of firms in foreign trade, as new firmlevel data sets became available. In these data, exporting firms differ systematically from
nonexporters. Scholars responded with the development of new models in which firms
are heterogeneous, and these models guided empirical studies with the new rich data sets.
Melitz and Redding review these developments in Chapter 1. After describing the
patterns of firm heterogeneity in the data, they develop an integrated multisector analytical framework for discussing many issues that have been analyzed in the recent literature. In the data, exporters differ from nonexporters in a number of dimensions; e.g.,
exporters are bigger and more productive than nonexporters and they pay higher wages.
PREFACE*
*We thank the National Science Foundation for financial support.
xiv Preface
Studies of trade liberalization show that it leads to substantial reallocation within industries; low-productivity firms exit while market shares are reallocated to more productive
firms, and especially to exporters. In addition, firms and product margins are important
determinants of trade flows, because variation in the number of products explains a large
fraction of the variation in trade volumes. These are some of the findings that motivated
the original theoretical analysis that Melitz and Redding review in this chapter.
The analytical framework consists of sectors that have the features developed in
Melitz (2003), as well as a homogeneous good sector (although the latter is shut down
in some applications). Firms enter an industry in anticipation of a productivity draw.
After the entry cost is sunk and a firm’s productivity revealed, the firm has to decide
whether to stay in the industry or exit. If it stays, it has to decide whether to serve only
the domestic market or also export. There is a fixed cost of operation and a fixed cost of
exporting, as well as variable trade costs. In the now familiar manner, firms choose among
these strategies based on productivity: the least productive firms exit, the most productive
become exporters, and intermediate-productivity firms serve only the domestic market.
Although these results are not new, the exposition is new and intuitive, making the
analysis accessible to many readers. This useful feature characterizes the entire chapter.
It is especially helpful in the discussion of within-sectoral reallocations in response to
declining trade costs and the home market effect.
Melitz and Redding also explain how these models have guided estimation of
trade flows and quantitative analysis. Some of these issues are discussed in more detail
in Chapter 3 on gravity equations and in Chapter 4 on trade theory with numbers.
They also discuss the integration of factor proportions into the multisector framework
and some of its consequences, such as the relationship between factor endowments and
endogenous sectoral productivity levels.
Up to this point preferences for variety were assumed to be of the constantelasticity-of-substitution type, resulting in constant markups in percentage terms. In
Section 8, Melitz and Redding replace those preferences with a generalized quadratic
system that yields linear demand functions with an intercept that depends on sectoral
conditions. Under these circumstances markups vary across firms and they respond
to demand and supply shocks. Since trade is costly, international markets are not fully
integrated and market size impacts markups and average sectoral productivity levels. As
a result, productivity is higher and markups are lower in larger economies.
In this case multilateral trade liberalization leads to exit of low-productivity firms
and market share reallocation toward more productive firms, including exporters, but in
addition it reduces markups. The result is that prices are lower because of both higher
productivity and lower markups.
Section 9 then examines endogenous firm-specific productivity levels, by allowing
firms to engage in innovation or technology adoption that augments their productivity
draws. Choice of product scope for multiproduct firms is also considered, which provides