Wilfred J. Ethier on trade and trade policy

This special issue is to celebrate Wilfred J. Ethier, who passed the 70-year mark earlier this year. There are many reasons to celebrate Bill. For instance, Bill is extremely warm and kind, and he has a profound sense of humor, with a particular taste for the absurd and for self-irony. But Bill is not just a truly great friend, he is also a great and much admired scholar, which is the pretext for putting together this issue. Bill took an A. B. in Mathematics at the University of Rochester, where he stayed to take a Ph.D. in Economics with Ronald W. Jones as main advisor and Lionel McKenzie as a teacher-quite some start for a career as a trade theorist! In 1969, Bill became Assistant Professor at University of Pennsylvania, where he remained until retirement earlier this year. Over the years Bill has been a frequent flyer, holding visiting positions in a large number of departments and institutes, such as in Stockholm, Jerusalem, Osaka, Turin, Rotterdam, Kiel, Copenhagen, Kobe, Hong Kong, Seoul, and Tbilisi. Bill's work is easily characterized in certain respects: It is all theory. It is all international economics. It is all highly original. It is all elegantly packaged in almost literary prose. It is (almost) all hard reading. Much harder to describe in a few words are all the contributions he has made to the literature. What follows only superficially describes the broad contours of his work to date. One of the first issues that Bill highlighted was the notion of the effective rate of protection. The idea behind this concept, which was very popular among applied trade economists in the 1960s and 1970s, is to measure the net tariff protection provided to an industry, taking into account not only direct tariff protection of the industry, but also tariffs on goods that are used as inputs through the whole chain of production of the good. Bill immediately revealed his analytical skills, in particular through a celebrated paper [3] that highlighted the restrictiveness of the conditions under which the measure would be useful in practice. These skills were also displayed early in his career in his work on open-economy macro issues, and in particular exchange rate dynamics. True to his academic origins, Bill spent much of the 1970s and the 1980s extending the neo-classical trade model in a number of directions. Two themes were particularly prominent. One concerned the role of the dimensionality of the classical trade model, which assumes a setting where two countries trade two goods that are produced using two factors of production: the “” model. In seminal work Bill showed how the basic predictions from this model concerning, for example, gains from trade, trade patterns, and factor price equalization, could be generalized to economies with arbitrary numbers of countries, products and factors of production (see [12], and the chapter on higher-dimensional trade in the Handbook of International Economics, Vol. 1 [14]). Another prominent line in Bill's research during the 1980s was to extend the classical trade models to allow for international factor mobility, studying legal as well as illegal labor migration, foreign direct investment (FDI) and multinational firms. But Bill also worked on a large number of other issues, including non-traded goods, joint production, and time-phased economies. A number of important contributions by Bill deal with the role of scale economies for the validity of the predictions from the classical factor-proportions trade model concerning international patterns of production, and for the role of trade policy (in particular, [29], [31], and [32]). Most work on scale economies and trade in the late 1970s and early 1980s studied increasing returns to scale that require geographical concentration of production-what Bill denotes “national” returns. Bill highlights the interaction of such economies with “international” economies that arise from specialization in production (or division of labor) but that do not require geographical concentration but only depend on the global size of the market. Bill shows that with international increasing returns to scale, a form of intra-industry trade in intermediate products may arise between similar economies, and that inter-industry trade arises when countries differ significantly in the irrelative factor endowments, in line with predictions from traditional comparative advantage theory. Over the years, Bill's work has increasingly come to focus on trade policy. This body of work can broadly be divided into three categories. A number of important studies focus on unilateral aspects of trade policy, such as managed trade, voluntary export restraints, and administered import protection (dumping, in particular). But the main focus in Bill's work during the last 20 years has been on trade agreements, where he has made a number of important and original contributions. One line of inquiry has addressed preferential (or regional) trade agreements (PTAs). Bill's contributions to the huge literature on PTAs have been truly novel, in terms of methodology and findings. The literature on PTAs has focused on two issues in particular. One is whether this discriminatory form of trade liberalization reduces world welfare. To shed light on this issue, most analyses have employed the Vinerian concepts of trade creation and trade diversion to study the effects of exogenously formed PTAs. The other, more policy-oriented, debate has concerned whether the formation of PTA hinders the process of multilateral trade liberalization. In [52], Bill approaches PTAs from a very different perspective than in the rest of the literature. PTAs are seen as means for countries that are in the process of political reform to attract FDI, rather than as substitutes for the lack of multilateral liberalization. On this view, PTAs hence arise endogenously in the analysis, in contrast to in the traditional literature. Furthermore, since PTAs help reforming countries enter the multilateral trade system, they promote rather than hinder multilateralism. This view is starkly different than the dominant views in the traditional literature. A similar line of argument is also developed in [51]. The latter study is also highly innovative from another point of view: it is, as far as we know, the first time the structure of trade agreements is derived endogenously using an explicit model of contracting costs. Bill's other line of work on trade agreements concerns the complementary process to regionalism: multilateral trade liberalization (i.e., the General Agreement on Tariffs and Trade (GATT) and the World Trade Organization (WTO)). Just like his contributions on PTAs, this body of work is based on careful study of the institutional setting in which trade agreements are formed. But Bill's work on multilateralism covers an even broader range of issues. One line of inquiry highlights the rationales for salient features of the GATT/WTO, addressing issues such as: What is the role of the most-favored nation clause that prevents countries from discriminating among their trade partners? Why are importing countries allowed to unilaterally offset the subsidies that the imported products have benefited from through countervailing duties? Why are export subsidies prohibited, and should importing countries not welcome these? What explains the design of the dispute settlement mechanism, for instance, the fact that the agreement mainly constrains permissible counter-measures? Why is the process of trade liberalization gradual? Bill provides novel answers to all of these issues and to many other important facets of the GATT/WTO. One issue that Bill has lately been particularly occupied with is the fundamental question of what trade agreements are for. The standard view among trade theorists is that the purpose of trade agreements such as the GATT is to deal with the so-called “terms-of-trade externalities” between countries, that is, the international consequences of countries deliberately seeking to exploit national market power in international markets. Bill has strongly rejected this notion, arguing that the GATT actually permits countries to unilaterally manipulate their terms of trade, since it allows countries to use export taxes to this end; in Bill's view, the fact that countries by and large have refrained from using this opportunity shows that the purpose of the GATT is not to prevent terms-of-trade manipulation. Bill also questions the important role that trade revenue plays in the conventional explanations for1 trade agreements, arguing that in real world policy makers do not seem to be motivated by revenue when imposing trade barriers. Bill argues that the role of trade agreements should instead be sought in international “political externalities” from unilateral trade policy setting, stemming from voters’ incomplete understanding of the exact nature of the link between trade policies and outcomes. For instance, in [72], such effects arise in a setting where voters are assumed to understand the direct effects of trade policy changes, but to be unaware of their general equilibrium ramifications. The debate on these issues remains far from settled. But we are convinced that time will show that Bill is right in emphasizing the importance of cognitive limitations for the formation and design of trade agreements. Let us know turn to the contents of this special issue, which consists of three parts. Following this introduction, the first part is devoted to the theoretical treatment of higher-dimensional trade models, to which Bill has made seminal contributions, as pointed out above. Alan Deardorff's article highlights the role of trade costs in the determination of a trade pattern. The article shows how trade patterns can vary with costs of trade. It then derives two correlations relating trade patterns to measures of comparative advantage that take account of both autarky prices and the costs of trade. Finally, the paper examines the role of trade costs in a trade model with product differentiation. In the next article, Eric Fisher studies a decomposition of a technology matrix into a definition of composite commodities, a definition of composite factors, and a simple map of composite factor prices into composite goods prices. This is applied to compute Rybczynski effects. In the third article, Kazumichi Iwasa and Kazuo Nishimura deal with intertemporal resource allocation through trade in a model with infinitely many future commodities. They investigate a dynamic Hecksher-Ohlin model with a production externality in which the capital good is also consumable. In this setting, they demonstrate that opening of trade can generate expectation-driven fluctuations in a world trade market. The second part of this special issue addresses another area to which Bill has made lasting contributions: the analysis of multinational corporations and FDI. In the first paper, Jim Markusen and Yiqing Xie compare outsourcing with vertical integration by extending the important work of Ethier [21] and Ethier and Markusen [27], which focuses on knowledge-based assets. The paper shows that vertical integration tends to be chosen when the technology is relatively knowledge-intensive and/or when knowledge and physical capital are strong complements. In the second paper, Amy Glass and Kamal Saggi study the role of tax policies to coordinate inward FDI. They demonstrate that, by reducing its tax on multinational production, a host country can attract additional FDI, some of which is diverted from other host countries. The shift in FDI causes host wages to rise while wages elsewhere fall. Coordination between hosts eliminates the FDI diversion effect and leads them to impose a harmonized FDI tax that is larger than their non-cooperative tax levels. In the third paper, Carl Davidson and Steve Matusz study the role of managers by adding heterogeneous workers and search-generated unemployment to a Melitz-style economy. This study gives a new foundation to the analysis of multinational firms. The third part of this issue presents work in yet another area to which Bill has made seminal contributions: the international regulation of unilateral policies. In the first article, Kamal Saggi studies the causes and consequences of regional exhaustion of intellectual property. For this purpose, the paper studies the case in which two high-income countries jointly choose their common exhaustion policy among national, international, or regional exhaustion. The key result is that the two high-income countries choose to implement regional exhaustion when they are relatively similar to each other and sufficiently high-income relative to the third country. In the second paper, Yuichi Furukawa and Makoto Yano study the technology diffusion that takes place when a “Southern” country free-rides on a “Northern” country's investments in innovation. They demonstrate that legal factors concerning intellectual property law in the South need to be coordinated with more basic factors such as moral and ethics for honoring Northern innovation. In the final paper, Henrik Horn and Petros Mavroidis investigate the appropriate role of multilateral environmental agreements in WTO dispute settlement. Its distinguishing feature is to examine this issue in light of a rationale for why countries have chosen to separate their obligations into two bodies of law without providing an explicit nexus between them. Their basic conclusion is that MEAs should not be understood to impose legally binding obligations on WTO members, but could still be used as sources of factual information. It is a testimony to the breadth, novelty and relevance of Bill's work that these newly written papers address areas to which Bill has made seminal contributions. Bill's research has always been ahead of its time. [1] Ethier, W. J. (1971), “General equilibrium theory and the concept of effective protection,” H. Grubel and H. Johnson, eds, Effective Tariff Protection, 17–42, Geneva: GATT and GIIS. [2] Ethier, and W. J. (1972), “Input substitution and the concept of the effective rate of protection,” Journal of Political Economy 80, 34–47. [3] Ethier, W. J. (1977), “The theory of effective protection in general equilibrium: Effective-rate analogues of nominal rates,” Canadian Journal of Economics 10, 233–45. [4] Ethier, W. J. (1973), “International trade and the forward exchange market,” American Economic Review 63, 494–503. [5] Ethier, W. J. (1975), “Financial assets and economic growth in a 'Keynesian' economy,” Journal of Money, Credit and Banking 7, 215–33. [6] Ethier, W. J., and A. I. Bloomfield (1975), Managing the Managed Float, Princeton, NJ: International Finance Section, Dept. of Economics, Princeton University. [7] Ethier, W. J. (1976), “Exchange depreciation in the adjustment process,” Economic Record 52, 443–61. [8] Ethier, W. J., and A. I. Bloomfield (1976), “The management of floating exchange rates,” P. Boarman and D. Tuerck, eds, World Monetary Disorder, 173–89, New York: Praeger. [9] Ethier, W. J. (1978), “Exchange depreciation and induced inflation,” T. Baggiotti and G. Franco, eds, Pioneering Economics: Essays in Honor of Giovanni Demaria, 297–312, Padua: CEDAM. [10] Ethier, W. J., and A. I. Bloomfield (1978), “The reference rate proposal and recent experience,” Quarterly Review of the Banca Nazionale del Lavoro 126, 211–32. [11] Ethier, W. J. (1979), “Expectations and the asset–market approach to the exchange rate,” Journal ofMonetaryEconomics 5, 259–82. [12] Ethier, W. J. (1974), “Some of the theorems of international trade with many goods and factors,” Journal of International Economics 4, 199–206. [13] Ethier, W. J. (1982), “The general role of factor intensity in the theorems of international trade,” Economic Letters 10, 337–42. [14] Ethier, W. J. (1984), “Higher dimensional issues in trade theory,” P. B. Kenen and R. W. Jones, eds, Handbook of International Economics, Ethier, W. J., and A. (1971), “International capital and Journal Economics 1 Ethier, W. J. “International trade and labor American Economic Review Ethier, W. J. “International trade theory and international and Ethier, W. J. The host country American Economic Review Ethier, W. J., and “The theorems of international trade with factor Journal of International Economics J. American Economic Review [21] Ethier, W. J. “The multinational Quarterly Journal of Economics Ethier, W. J. international factor H. and Ethier, W. J., and H. Horn of international and patterns of direct Journal of International Economics Ethier, W. J. on and Trade in a H. in the World Ethier, W. J. from trade, and theory,” P. and R. eds, in International Ethier, W. J. in the theory of international trade,” Economics in a Vol. Trade and the of the World of the International Economic Ethier, W. J., and J. R. Markusen technology diffusion and trade,” Journal of International Economics Ethier, W. J. trade liberalization and or P. J. and eds, International Trade and in The University Ethier, W. J. (1979), costs and world trade,” Journal of International Economics Ethier, W. J., and A. (1979), from trade and the size of a Journal of International Economics Ethier, W. J. (1982), and international returns to scale in the theory of international trade,” American Economic Review Ethier, W. J. (1982), costs in international trade and argument for protection,” Ethier, W. J., and A. (1984), size of country and gains from trade,” Economic Journal Ethier, W. J. trade and and B. J. eds, The in University Ethier, W. J., and R. J. economies of scale and comparative T. and eds, International Trade and Economic Essays in of New York: Ethier, W. J. (1971), “The two production A and an to Economic 10, Ethier, W. J. goods and the International Economic Review Ethier, W. J., and (1976), on joint production and the theory of international trade,” in Ethier, W. J. (1979), “The theorems of international trade in time-phased Journal of International Economics W. W. J. Ethier, and “The theorems of international trade with joint Journal Economics 10, Ethier, W. J. to and Journal Economics Ethier, W. J. (1984), and real Quarterly Journal of Economics Ethier, W. J. 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J. “The trade agreements and its and J. eds, Economic For a for International Economic Ethier, W. J. International Handbook Vol. Ethier, W. J. (1982), Journal of Political Economy Ethier, W. J. (1984), of and The case of R. and A. eds, The and of Trade University of and Ethier, W. J., and R. “The new Journal of International Economic Ethier, W. J. J. and P. eds, The New Ethier, W. J. “The and political of managed trade,” A. and Ethier, W. J. export A. and H. eds, and International Ethier, W. J. in an T. International Trade of Ethier, W. J. law with a market,” H. and eds, and Economic University Ethier, W. J., and H. Horn trade Review of International Economics 4, Ethier, W. J. The International Princeton, NJ: International Finance Dept. of Economics, Princeton University Princeton Ethier, W. J. in trade Journal of Political Economy Ethier, W. J. in a multilateral Economic Journal Ethier, W. J. and in the multilateral trade R. and eds, to the World Ethier, W. J. property and dispute settlement in the World Trade Journal of International Economic 7, Ethier, W. J. and a multilateral Review Economics Ethier, W. J. and dispute settlement in trade The of Economic Ethier, W. J. for Journal of Economics Ethier, W. J. the WTO for G. P. eds, WTO and University Ethier, W. J. “The theory of trade policy and trade A Journal of Political Economy Ethier, W. J. “International trade and eds, and in Trade and W. Ethier, W. J. agreements and dispute settlement in the WTO J. Trade and the Ethier, W. J. “The political of protection,” D. R. D. and eds, Handbook Ethier, W. J. “The approach to protection,” Economic Journal (in

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