International Economic Integration and Domestic Performance

The following sections are included:

• About the Author
• Preface and Acknowledgements
• Contents
• The Power of Mobility

Because noncompliance has efficiency and equity implications, it should be a concern in the design of the commodity tax structure. This article derives the optimal commodity tax conditions and modifications to their standard interpretation when consumers engage in costly border crossing to evade local taxes. It presents a model of costly noncompliance behavior and a modified version of Roy’s theorem describing the effect on indirect utility of a tax change when cross-border shopping occurs. This modified Roy’s theorem permits the inverse elasticity rule, proportionate shrinkage rule, and covariance interpretation of the optimal tax conditions to be adapted to the case of costly noncompliance.

This paper compares discrete equilibria in which consumers do and do not evade commodity taxes by making cross-border purchases. When the government faces a revenue requirement, the comparison shows that border crossing reduces welfare if resources wasted by evasion exceed the benefit of consumption changes, where these changes reflect lower prices across the border and induced changes in domestic tax rates. Enforcement reduces welfare if administrative and uncertainty costs outweigh the benefits of consumption changes and the reduction in resource costs. The analysis shows that the welfare effect of evasion depends on how well designed the tax system is and how effective enforcement resources are in deterring border crossing.

In a small, open economy characterized by an increasing-returns sector and foreignowned capital, a sector-specific instrument generally is needed to achieve the optimum. A capital subsidy alone can be used for decentralization, however, when the optimal production plan is specialization in the externality-generating activity. The effect of a capital subsidy on home income and its distribution depends on the pattern of production and the share of domestic capital that is foreign owned. In a diversified economy, a subsidy benefits capital owners, harms labor and raises national income only if foreign capital ownership is sufficiently small. In a specialized economy, a subsidy may raise national income even if all domestic capital is foreign owned and, if it does, both labor and capital owners gain. Thus, a capital subsidy may be an attractive replacement for sector-specific subsidies proscribed by international agreements.

Proponents of industrial policy argue that key industries merit subsidies because they generate beneficial externalities. We show that policy must reflect both technological linkages and market power in the target industries, the interaction of which may produce an optimal policy including both subsidies and taxes on target industries. The optimal policy combination may not be politically or administratively feasible. If so, we show that it may not be desirable to subsidize output in the externality-generating activity on either a fixed or per-unit basis. Thus, technological linkages alone do not lead to the presumption that the externality-generating activity should be subsidized.

We examine the productivity of public infrastructure in a general equilibrium context. In our model, infrastructure lowers costs in a manufacturing sector characterized by both firm-level returns to scale and industry-level external returns to variety. Infrastructure alters factor prices, intermediate prices and the allocation of factors across sectors. However, the effect on manufacturing or aggregate output is indeterminate. In particular, our theory suggests that the degree of monopoly power influences public capital’s productivity effect. We test the model using state-level, panel data. We confirm the absence of direct effects on output, but find evidence to suggest a positive impact of public capital on manufacturing variety as measured by the number of manufacturing establishments. These results indicate the need for future research on potentially important indirect channels by which public capital affects manufacturing productivity.

Although longstanding arguments suggest that the need to acquire information contributes to spatial concentration of employment, few studies have provided evidence on this point. This paper addresses this issue by examining the spatial concentration of headquarter activity of exporters. Exporting requires specialized knowledge of foreign markets and should, therefore, contribute to spatial concentration. We test this idea by applying differencing methods to 4-digit industry-level data for the fourth quarter of 2000. Results suggest that when foreign market information is difficult to obtain, exporter headquarter activity is more agglomerated. Results also indicate that the sensitivity of agglomeration to foreign trading environments depends on the underlying characteristics that define countries as “difficult”.

We use the US International Trade Commission’s uniquely detailed 1995-2007 Chinese Customs data to better understand the pattern of trade between China and its two largest trading partners, Japan and the United States. Our review finds that only a small share of these flows can be characterized as arm’s length, one-way trade in final goods. Instead, we find extensive two-way trade, deep vertical specialization, concentration of trade in computer and communication devices, and a prominent role for foreign-invested enterprises. While these characteristics define both bilateral relationships, important differences between the two pairs do emerge, suggesting that trade costs influence the method by which multinationals choose to integrate their production with China. Consequently, we argue that dialogue on East Asian trade liberalization should include the possibility of significant production gains for the US from its inclusion in any regional agreements.

This paper finds that the evidence for the home market effect (HME) found by Hanson and Xiang (AER, 2004) is sensitive to the way the dependent and the independent variables are constructed. Second, we also find that the HME evidence goes away when we estimate their difference-in-difference gravity model on a truncated sample of positive trade flows. With Eaton–Tamura–Tobit, Heckman, and Helpman–Melitz–Rubinstein estimation of the gravity equation using Hanson and Xiang’s data, we are unable to find any evidence for the HME. Finally, the HME evidence is also absent for a sample of Canadian provinces’ exports to U.S. States. All of our results, taken together, do not reject the existence of the HME in general but rather suggest that the HME results found by Hanson and Xiang may not be robust.

At the center of the pollution haven debate is the claim that foreign investors from industrial countries are attracted to weak environment regulations in developing countries. Some recent location choice studies have found evidence of this attraction, but only for inward FDI in industrial countries. The few studies of inward FDI in developing countries have been hampered by weak measures of environmental stringency and by insufficient data to estimate variation in firm response by pollution intensity. This paper tests for pollution haven behavior by estimating the determinants of location choice for equity joint ventures (EJVs) in China. Beginning with a theoretical framework of firm production and abatement decisions, we derive and estimate a location choice model using data on a sample of EJV projects, Chinese effective levies on water pollution, and Chinese industrial pollution intensity. Results show EJVs in highly-polluting industries funded through Hong Kong, Macao, and Taiwan are attracted by weak environmental standards. In contrast, EJVs funded from non-ethnically Chinese sources are not significantly attracted by weak standards, regardless of the pollution intensity of the industry. These findings are consistent with pollution haven behavior, but not by investors from high income countries and only in industries that are highly polluting. Further investigation into differences in technology between industrial and developing country investors might shed new light on this debate.

Focusing specifically on regulation of coal-fired power plants, we examine how technological innovation by early adopters influences the timing of new environmental regulation in non-innovating countries. We build a general equilibrium model of an open economy to identify the political-economy determinants of regulation. With a newly created dataset of SO₂ and NO_x regulations for coal-fired power plants and a patent-based measure of the technology frontier, we estimate the determinants of environmental regulation diffusion. Our findings support the hypothesis that international economic integration eases access to environmentally friendly technologies and leads to earlier adoption, ceteris paribus, of regulation in non-innovating countries. However, we also find evidence that domestic trade protection promotes earlier adoption allowing shifts of regulatory costs to domestic consumers. Furthermore, international market power permits large countries to shift costs to foreign consumers. Other political economy factors, such as the quality of domestic coal, are also important determinants.

There is almost no support for the proposition that capital is attracted to low wages from firm-level studies. We examine the location choices of 2,884 firms investing in China between 1993 and 1996 to offer two main contributions. First, we find that the location of labor-intensive activities is highly elastic to provincial wage differences. Generally, investors’ wage sensitivity declines as the skill intensity of the industry increases. Second, we find that unobserved location-specific attributes exert a downward bias on estimated wage sensitivity. Using a control function approach, we estimate a downward bias of 50% to 90% in wage coefficients estimated with standard techniques.

The following sections are included:

• INTRODUCTION
• CONTROL-FUNCTION CORRECTIONS FOR OMITTED ATTRIBUTES
• THE LOCATION CHOICE MODEL
• DATA DESCRIPTION AND SOURCES
• RESULTS
• CONCLUSION
• APPENDIX A
• REFERENCES

Using China’s Annual Survey of Industrial Production, we estimate the marginal revenue product of labor (MRPL) for all state-owned and above-scale non-state manufacturing firms for 2001-2004 and 2004-2007. We find that labor productivity varies systematically within industries by ownership type and thai non-state firms face implicit labor taxation relative to state-owned enterprises (SOEs). We also find that, in keeping with ongoing reforms of the state sector, ownership differentials fall over time, with gaps between non-state enterprises and SOEs falling by about half over time. Within the non-state sector, enterprises registered as legal persons have higher MRPL, on average, than do firms registered as collective or private enterprises. Disaggregating this group using information on equity shares reveals that firms registered as legal persons and majority owned by legal persons have the highest MRPL relative to SOEs. Indeed, these enterprises show significantly higher MRPL than those firms directly controlled by the state. Legal-person firms with majority state ownership have MRPL differentials similar to those for legal-person firms with majority private or majority collective ownership. This evidence is consistent with continuing, albeit diminishing, implicit labor subsidies for directly SOEs but not for firms whose shares are owned by the state, even if those shares are registered to legal persons.

New economic geography models predict that costly transport and the spatial distribution of demand affect the profits firms can earn in different locations, leading to higher wages for workers employed in cities with better geographic access to markets. In light of the dramatic embrace of globalization and labor market reforms that occurred in China after 1995, we measure the extent to which the influence of market access on wages strengthened and influenced wage growth over the subsequent period. Using survey data from two waves of the Chinese Household Income Project, we find that urban wages became more strongly influenced by access to markets, including domestic markets, between 1995 and 2002. The estimated elasticity of the wage with respect to market access of the worker’s location more than doubles over the period. We also find that market access influences wages paid to both skilled and unskilled workers. Within provinces, we find no significant relationship between market access and either group’s wages when adjusted for living costs, as expected in the context of internal labor migration. However, across provinces wages net of living costs are positively correlated with the market access of the worker’s location. Consistent with deregulation of wage setting in state enterprises, the influence of market access on wages strengthened most for state-owned firms. A decomposition of the change in the mean wage indicates that market access is an economically important factor explaining the growth in average wages between 1995 and 2002.