Specialization, Market Access and Real Income

Specialization,MarketAccessandRealIncome DominickBartelme,TingLan,AndreiA.Levchenko WP/24/51 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2024 MAR ©YYYYInternationalMonetaryFund[WP/YY/XX] IMFWorkingPaper ResearchDepartment Specialization,MarketAccessandRealIncome PreparedbyDominickBartelme,TingLan,andAndreiA.Levchenko* AuthorizedfordistributionbyJaewooLee March2024 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:Thispaperestimatestheimpactofexternaldemandshocksonrealincome.Weutilizeafirstorderapproximationtoawideclassofsmallopeneconomymodelsthatfeaturesector-levelgravityintradeflows,whichallowsustomeasureforeignshocksandcharacterizetheirwelfareimpactintermsofreduced-formelasticities.Weusemachinelearningtechniquestogroup4-digitmanufacturingsectorsintoasmallernumberofclusters,andshowthatthecluster-levelelasticitiesofincomewithrespecttoforeignshockscanbeestimatedusinghigh-dimensionalstatisticaltechniques.Foreigndemandshocksincomplexintermediateandcapitalgoodshavelargepositiveimpactsonrealincome,whereasimpactsinothersectorsarenegligible.Weshowthattheestimatesimplythatcountriesthatspecializeinthesesectorsenjoygreatergainsfromincreasedopenness,andthat(small)exportsubsidiestothesesectorsarewelfare-improving.Finally,acalibratedmulti-sectorproductionandtrademodelwithinput-outputlinkagesandexternaleconomiesofscalecanmatchtheempiricalestimates. RECOMMENDEDCITATION:Bartelme,Dominick,TingLan,andAndreiA.Levchenko,2024,“Specialization,MarketAccessandRealIncome,”IMFWorkingPaper24/51. JELClassificationNumbers: F43,F62 Keywords: tradespecialization;realincome;gravity;k-meansclustering Author’sE-MailAddress: dbartelm@umich.edu,tlan@imf.org,alve@umich.edu *“TheauthorswouldliketothankChristianHansen,KalinaManova,FernandoParro,JohnRies,AndrésRodríguez-Clare,SebastianSotelo,DanTrefler,andworkshopparticipantsatAEA2021,Berkeley,CEPRMG,CUHK,IADB,MSU,NBERITI,theNYUAD-CEPR“TheEndofGlobalization?”Conference,theRockyMountainEmpiricalTradeConference,SciencesPoSummerWorkshop,Texas,Toronto,theTradeIntegrationandGrowthConference(Bogota),WesternOntario,andYaleforhelpfulsuggestions,andJunweiTangforsuperbresearchassistance. IMFWORKINGPAPERSSpecialization,MarketAccessandRealIncome WORKINGPAPERS Specialization,MarketAccessandRealIncome PreparedbyDominickBartelme,TingLan,AndreiA.Levchenko INTERNATIONALMONETARYFUND 1.Introduction Howmuchdocountriesbenefitfromaccesstotheinternationalmarket?Arethewelfareeffectsofforeignmarketaccessinsomesectorslargerthaninothers?Dosomecountries,byvirtueoftheircomparativeadvantage,benefitmorefromglobalization?Howshouldtradeandindustrialpolicyrespondtothesesectoraldifferences?Thesequestionsareattheheartofthestudyofinternationaltradeaswellasrecentpolicydebates.Animportantandactivetradition,followinginthefootstepsofEatonandKortum(2002),tacklesthesequestionsusingquantitativemodelsthatarecalibratedtodataandmicro-levelelasticities.Whilethisapproachhasbeentremendouslyanddeservedlyinfluential,itslimitationisthatthegeneralequilibriumoutcomesareoftensensitivetomodelfeatures(e.g.CostinotandRodríguez-Clare,2014;Kehoeetal.,2017).Becausethegeneralequilibriumpredictionsaretypicallyneitherdisciplinedbynortestedagainstthedata,thesequantificationsprovidelittleguidanceastowhich(ifany)ofthemanypossiblemodelsgivereliableanswerstothesequestions. Thispapertakesanalternativeapproach:wedirectlyestimatethegeneralequilibriumimpactofforeignshocksindifferentsectors.Ourmethodsstrikeabalancebetweentheclarityandrigorofthequantitativetraditionandmoremodel-robuststatisticalmethodsthat“letthedataspeak.”Webeginbyshowingthatinalargeclassofmulti-sectorsmallopeneconomymodelswithsector-levelgravityequations,allrelevantinformationregardingexternaldemandinagivencountryandsectorissummarizedinasinglevariablewhichwecallexternalfirmmarketaccess.Thisobjectcanbeestimatedfromtradedatausingstandardtechniques,andreflectsthegeographyofsector-leveltradecostsandforeigndemand.Wethendefineanelasticityofwelfare(equivalently,realpercapitaincome)withrespecttosector-specificexternalfirmmarketaccess.Thiselasticityreflectsthelongrunbenefitsofexportmarketaccessinasector,aggregatingalltherelevantmicroeconomicmechanismsandfeaturesoftheinitialstateoftheeconomy. Expressingtheimpactofforeignmarketaccessintermsofwelfareelasticitieshasthreebenefits.First,thesegeneralequilibriumelasticitiescanbeestimatedeconometricallyinatheory-consistentway.Second,thesewelfareelasticitiesareintimatelyconnectedwiththewelfareeffectsoftradeandindustrialpolicy.Wederivesufficientstatisticsforthefirst-orderwelfareimpactsofforeigntariffs,domesticexporttaxesand(underadditionalrestrictions)domesticproductio