Copenhagen Economics Institute Short Course March 5-7 2007

1. Copenhagen Economics InstituteShort Course March 5-7 2007 Globalization in the Very Long Run March 7 Political Economy: Protection and Immigration

2. Part 1. The political economy of protection

3. Motivation What determines tariff policy? It can’t be conventional economics, since every mainstream economist since Smith (1776) agrees that free trade is a good thing for national income. Yet, the politics of free trade have been surrounded by controversy ever since Alexander Hamilton tried forcing his protectionist policies on a new United States congress after 1789, and since Robert Peel ruined his political career forcing free on the British Parliament in 1846. Political leaders have never been solely, or even largely, interested in maximizing national income, let alone maximizing world income. Their main goal has always been to get a larger slice of the pie for their supporters. Protection and free trade have always been for sale in the political market place (Grossman and Helpman 1994), but having said so doesn’t make the question -- what determines tariff policy? – much easier to answer.

4. A word of warning Europeans, please note!The belief that pre-1914 trade policies were liberal is a Big Myth created by scholarly obsession with western Europe. Blame your Euro-centric Teachers!

5. Road Map • Four big world tariff facts • Do immense tariffs always mean globalization backlash? • Endogenous tariffs in the world economy 1870-1938 • Endogenous tariffs even earlier: Zollverein 1818-34; US after 1789; Latin America after 1823

6. Four big tariff facts First: Inflations and deflations played a powerful role at key points in the past. Import duties were typically specific until modern times, quoted as pesos per bale, dollars per yard, or yen per ton. Under a regime of specific duties, abrupt changes in price levels changed import values in the denominator, but not the legislated duty in the numerator, thus producing big percentage point changes in equivalent ad valorem tariff rates.

7. Second: The well-known surge to world protection in the interwar is almost matched by a less well known protectionist drift worldwide between 1865 and about 1900. And what looks like a modest pre-World War I anti-globalization backlash – led by a European retreat from the liberal pro-global trade positions in mid- century -- is far more dramatic when the world averages are disaggregated. Indeed, there is a very pronounced rise in tariffs across Latin America, across the non-Latin European offshoots and across the European periphery. This steep rise up to the 1890s in the periphery’s tariff rates far exceeds that of the European core, a notable fact given that almost nothing has been written on this anti-global tariff trend in the periphery.

8. Third: There was enormous variance in levels of protection between regions. The richer new world European offshoots had levels of protection almost three times that of the European core around 1900. To take a second example, in 1925 the European periphery had tariffs about two and a half times higher than those in the European part of the industrial core. To take a third example, in 1885 the poor but independent parts of Latin America had tariffs almost five times higher than those in the poor and dependent parts of Asia, while the poor but independent parts of Asia had tariff rates about the same as the poor but dependent parts of Asia.

9. Fourth: There was great variance within regions. In 1905, tariffs in Uruguay were two and a half times those in Canada, while tariffs in Brazil and Colombia were ten times those in China and India. The same high-low range appeared within the industrial core (US five times the UK) and the European periphery (Russia six times Austria-Hungary). From 1919 to 1938, the tariff variance between countries was about the same as tariff variance over time, but from 1865 to 1914, the tariff variance between countries was more than twice that of the tariff variance over time. Thus, explaining differences in tariff policy between countries may be even more challenging then explaining tariff policy changes over time.

10. Addendum In the new economic order (Lewis), labor-abundant and land-scarce Europe exported manufactures and imported primary products. The periphery did the opposite. Thus, European tariffs were mainly imposed on import-competing primary products (and higher than their average) while periphery tariffs were mainly imposed on import-competing manufactures (and higher than their average). In others words, future work needs to look at the structure of protection.

11. Restrictive trade policy in the First Global Century The 35-country sample (85% of 1914 world population, 95% of 1914 world GDP) 6 Core industrial leaders: AH, Fr, Ger, It, UK, USA 8 European Periphery: Den, Grc, Nor, Port, Serb, Sp, Swe, Rus 8 Latin American Periphery: Arg, Brz, Col, Ch, Cuba, Mex, Per, Ur 10 Asia-MidEast: Bur, Cey, Egy, Ind, Indo, Jap, Phil, Siam, Turk 3 English-speaking European Offshoots: Aus, Can, NZ

14. Endogenous Tariffs in Table 1Right-hand side variables (all but dummies in logs): • Export Share: X/GDP, a measure of a country’s export boom or slump. Revenue tales;

15. A Note on Tariffs for Revenue R = tpM where R is revenue, t is the average ad valorem tariff rate, p is the average import price and M is import volume. Totally differentiating with respect to t, and assuming that the typical 19th century country in the periphery was a price taker for manufacturing imports, yields dR/dt = pM + (tp)dM/dt. The revenue-maximizing tariff rate, t*, is found by setting dR/dt = 0 in which case t* = -1/(1 + e) where e is the price elasticity of demand for imports. Irwin (1998) estimates e to have been about -2.6 for the US between 1869 and 1913, so assuming e = -3 can’t be too far off the mark. In which case, the revenue-maximizing tariff in the periphery would have been very high indeed, about 50 percent.

16. Suppose some government in the periphery had in mind some target revenue share in GDP R/Y = r and could not rely on foreign capital inflows to balance the current account (so pM = X), then r = tpM/Y = tX/Y If foreign exchange earnings from imports (and thus imports) were booming (an event which could be caused by a terms of trade boom, denoted here by a fall in the relative import price, p, or by a supply-side expansion of export quantities, X), then the target revenue share could have been achieved at lower tariff rate, t. Moral? The bigger the export boom, the higher the export share, the bigger the import share, and the lower the necessary tariff rate.

21. Tariff rates rise in the US

22. Was it all about List’s infant industry or was it about revenues?

27. Part 2. The political economy of immigration Actually, I think there’s a better way to pursue this. Namely, ask “Why Have Trade and Immigration Policies Always Differed in Labor-Scarce Economies?” a question Tim Hatton and I asked recently in The New Comparative Economic History (Cambridge, Mass.: MIT Press, forthcoming 2007).

28. The Policy Paradox • A century ago, trade policies were restrictive and immigration policies were liberal. • Today, trade policies are liberal while immigration policies are restrictive. • So, why have policies towards trade and immigration always differed in labor-scarce economies?

29. The simple HS-SS 2x2x2 model • As Robert Mundell (1957) pointed out 50 years ago, in the labor-scarce economy open immigration and free trade policies both lower wages, while restricted immigration and protection both raise wages. Thus, open immigration will offset the distributional impact of protection, and free trade will offset the impact of immigration restriction.

30. What accounts for the Paradox? Better theory could make the Paradox evaporate: After all, the predictions of HO-SS factor endowment model might be overturned by modifying it with specific factors, increasing returns or Ricardian differences in productivity. Better political economy could make the Paradox evaporate: After all, factor income distribution isn’t the only determinant of policy. We favor better political economy.

31. Road Map • The evolution of immigration restriction (less to more) and trade restriction (more to less) over two centuries. • Declining immigrant positive selectivity, declining immigrant ‘quality’ and rising immigrant restriction. • The fiscal implications of the rise of the welfare state for trade and immigration policy. • The role of suffrage in changing the median voter. • Forming public opinion and public policy. • The bottom line.

32. Refrain: World trade policy was restrictive in the First Global Century

33. Refrain: Trade policy was very restrictive in labor-scarce countries during the First Global Century

34. Liberal trade policy in the Second Global Century • Since 1950, labor-scarce countries have gone open. • The fact that the Third World stayed closed for so long (especially Latin America and eastern Europe) is irrelevant given our focus on trade policy in labor-scarce countries.

35. Open immigration policy in labor-scarce economies in the First Global Century • Index of policy stance for 5 major immigration countries: Australia, Argentina, Brazil, Canada and US (Timmer and Williamson 1998). • Index = -5 for tough quotas (including exclusion of those from poor countries), 0 for neutrality and +5 for generous subsidies.

37. Rising immigration restriction in the Second Global Century • Quotas of the interwar period continued (after temporary guestworker experiments) • But labor-scarce countries ‘leveled the playing field’ by removing racist restrictions on poor Third World immigrant source countries • The fact that OECD immigration has soared is not inconsistent with restriction. After all, the immigration would have been 5, 10 or 20 times higher without it.

38. Thus, the Paradox: liberal trade policy and restrictive immigration policy coexist today, in the second global century; and liberal immigration policy and restrictive trade policy coexisted in the first global century. • Why? Is the HO-SS model irrelevant, or is the political economy of policy formation much more complex?

39. The long run decline in immigrant positive selectivity and ‘quality,’ and the rise in immigration restriction • In the early 1800s, European overseas emigration was a trickle and it was very positively selected. • They came from the relatively developed northwest where an early industrial revolution had raised living standards. • They came from the middle and upper parts of the income and wealth distribution. • Even if the labor-scarce host countries only wanted immigrants like themselves, they did not have to use discriminatory policy to get that result. Long distances, high transportation costs and source country poverty kept out the poor from backward east and southeast Europe.

40. As you have seen, US native-born ‘quality’ rose 1870-1930

41. … while the ‘quality’ of US immigrants fell.

42. … more on the fall of immigrant ‘quality’ as their numbers rose.

43. … and the long run relative quality decline continues. Relative wage and relative education: immigrants vs native-born US 1960-1990.

44. … and falling immigrant labor quality has left its mark on rising immigrant poverty rates. Poverty rates (%) US 1959 Foreign-born 14.2 Native-born 20.9 US 1999 Foreign-born 17.4 (up 3.1) Native-born 11.8 (down 9.1)

45. Summary of the road trip so far • Immigrant restriction since 1895 has been driven in large part by the long run decline in potential immigrant quality and their rising numbers. • The long run decline in immigrant quality would have been far greater without the rise of restrictions. • Immigration policy is much tougher now simply because there are vastly more potential immigrants from poor countries to keep out.

46. Changing fiscal implications of trade over two centuries. • Alexander Hamilton thought “the tariff was more important as a tool of fiscal policy than as an instrument for promoting manufactures.” • Customs duties were a major source of central government revenue in the 19th century, especially in labor-scarce and land-abundant overseas countries where low population and taxpayer density made other forms of taxation inefficient. • Tariff revenues are unimportant in labor-scarce countries today.

47. To repeat: tariffs were an important source of revenue then, but not now Customs duties/total tax revenues: Latin America 1820-1890 66% US 1850s 90 Australia 1850s 90 Ave. 7 labor-scarce 1890s 58 vs. UK and France 1890s <20 vs. OECD 1970s 4

48. Immigration, the rise of the welfare state and fiscal burdens. • Immigration had little fiscal impact in the first global century before the rise of the welfare state. The fiscal impact rose in the second global century with the decline in immigrant quality and the rise of the welfare state. • Thus, tariffs brought fiscal benefits and immigrants brought no fiscal costs before 1914. The opposite is true today.

49. The rise of the welfare state (implying rising net fiscal effects of immigrants).

50. Who gets the goodies?