Essays on International Trade, Growth and Finance by Marc-Andreas Muendler GRAD (University of Munich, Germany) 1998 M.A. (Boston University) 1997 A dissertation submitted in partial satisfaction of the requirements for the degree of Doctor of Philosophy in Economics in the GRADUATE DIVISION of the UNIVERSITY OF CALIFORNIA, BERKELEY Committee in charge: Professor Maurice Obstfeld, Co-Chair Professor David H. Romer, Co-Chair Professor Daniel L. McFadden Professor Ann E. Harrison Spring 2002 The dissertation of Marc-Andreas Muendler is approved: Co-Chair Date Co-Chair Date Date Date University of California, Berkeley Spring 2002 Essays on International Trade, Growth and Finance Copyright 2002 by Marc-Andreas Muendler 1 Abstract Essays on International Trade, Growth and Finance by Marc-Andreas Muendler Doctor of Philosophy in Economics University of California, Berkeley Professor Maurice Obstfeld, Co-Chair Professor David H. Romer, Co-Chair Two concerns in international economics motivate the essays. I. Does foreign trade harm or foster growth? Two essays look at this question from different perspectives. The first essay takes a dynamic general-equilibrium approach. Contrary to earlier partial-equilibrium models, the essay shows that trade can contribute to reducing the productivity gap between less developed and more advanced regions even if the advanced region hosts most of the innovative industries with dynamic externalities. Productivity may diverge in some cases. Even then both regions generally benefit more from trade than they lose. The second essay investigates microeconomic effects empirically. It analyzes the channels through which trade has induced productivity change in Brazil after the country liberalized its tariff act in 1990. The facilitated access to foreign inputs plays a minor role for productivity change. However, foreign competition pushes firms to raise efficiency markedly. Counterfactual simulations indicate that this competitive push is a salient source of immediate productivity change. In addition, the shutdown probability of inefficient firms rises with competition from abroad and exerts a positive 2 impact on aggregate productivity over time. II. What role does information play in financial markets? Evidence from financial crises suggests that investors possess information about troubled assets early on but do not act upon the information until a crisis looms. This behavior has consequences for the timing and prevention of crises. The two essays in this part introduce an integrated model of information acquisition and portfolio choice. The essays provide new tools for the analysis of information in financial markets, resolve a long-known no-equilibrium paradox, and clear the way for subsequent applied research into international financial crises. Employing different conjugate prior distributions, the essays demonstrate when investors value information and act on it. More information allows investors to select less risky portfolios. When the asset price is fully revealing, markets do provide information but less than socially desir- able. However, more information has a negative effect when becoming commonly known. Commonly shared information moves the asset price closer to the individually expected return, thus reducing the value of the risky asset. Professor Maurice Obstfeld, Co-Chair Professor David H. Romer, Co-Chair i To Beatriz ii Contents List of Figures vi List of Tables vii List of Abbreviations viii 1 Seizing the Chances of Globalization and Averting its Risks 1 1.1Internationaltradeandgrowth.............................. 2 1.2Informationinfinancialmarkets............................. 4 I International Trade and Growth 7 2 Trade and growth revisited: Managing to converge, agreeing to diverge 8 2.1TheModel......................................... 11 2.1.1 Production..................................... 11 2.1.2 Technologicalchange................................ 13 2.1.3 Demand....................................... 13 2.2 Autarky and Free Trade Equilibrium . ..................... 15 2.2.1 Monopolisticcompetitioninthemodernsector................. 16 2.2.2 Equilibrium number of varieties . ..................... 17 2.2.3 Autarky equilibrium . ............................ 18 2.2.4 Equilibrium under free trade . ..................... 20 2.3 Managing to Converge: The Technology Gap under Free Trade . ....... 27 2.3.1 Convergence under free trade . ..................... 27 2.3.2 P. Romer’s (1990) economy ............................ 32 2.4AgreeingtoDiverge:ADynamicWelfareAnalysis................... 33 2.4.1 Repeatedstaticgains............................... 34 2.4.2 Dynamicwelfareanalysis............................. 37 2.5Conclusion......................................... 41 3 Trade and productivity change: A study of Brazilian manufacturers, 1986-1998 43 3.1 Brazilian Trade Policy ................................... 47 3.2Data............................................. 49 3.3BehavioralFramework................................... 51 3.3.1 Assumptions.................................... 53 3.3.2 Afirm’sprice,factorandinvestmentchoice................... 55 iii 3.3.3 Competitionandamanager’sefficiencychoice................. 59 3.4Firm-levelProductivity.................................. 60 3.4.1 Production and foreign input efficiency . ..................... 61 3.4.2 Detailsonproductivityestimation........................ 63 3.4.3 Totalfactorproductivity............................. 70 3.5CausesofProductivityChange.............................. 72 3.5.1 Channel 1: Foreign Input Push . ..................... 73 3.5.2 Channel2:CompetitivePush........................... 76 3.5.3 Channel3:CompetitiveElimination....................... 81 3.5.4 Possibleadditionalchannels............................ 85 3.5.5 Counterfactualsimulations............................ 86 3.6Conclusion......................................... 90 II Information in Financial Markets 99 4 Another look at information acquisition under fully revealing asset prices 100 4.1AProblematicParadox.................................. 101 4.2TheModel......................................... 105 4.2.1 Investors’beliefs.................................. 109 4.2.2 The financial market equilibrium . ..................... 112 4.3 Information Equilibrium . ............................ 116 4.4InformationalEfficiencyandInformativenessofPrice.................. 127 4.5Conclusion......................................... 132 5 Towards a theory of information acquisition in financial markets 134 5.1Generalizations....................................... 135 5.2TheLucasTreeModelwithInformationAcquisition.................. 138 5.3FullyRevealingPrices................................... 144 5.3.1 The financial market equilibrium . ..................... 145 5.3.2 The information market equilibrium . ..................... 150 5.3.3 Informationalefficiency.............................. 154 5.4PartlyInformativePrices................................. 155 5.4.1 The financial market equilibrium . ..................... 156 5.4.2 Incentivesandexternalities............................ 162 5.4.3 The information market equilibrium . ..................... 172 5.4.4 Informationalefficiency.............................. 176 5.5Conclusion......................................... 179 6 An Outlook on Future Research into Globalization 183 Bibliography 186 iv A Data appendix to chapter 3: Pesquisa Industrial Anual and complementary data sources 197 A.1 PIA—WhatItContains,andWhatNot......................... 198 A.1.1Sample....................................... 198 A.1.2Variables...................................... 202 A.2LongitudinalRelationsbetweenFirms.......................... 202 A.2.1Statesofactivityandtypesofchange...................... 203 A.2.2Reclassificationsanderrorcorrections...................... 204 A.2.3Effectivesuspensionandexittimes........................ 206 A.2.4Identifyinglongitudinallinksina‘familytree’................. 206 A.2.5Afirm’s‘economiccurriculum’.......................... 207 A.2.6Afirm’seconomicage............................... 209 A.2.7Regionalclassifications............................... 210 A.2.8Sectorclassifications................................ 210 A.3 Compatibility of Economic Variables Over Time . .............. 210 A.3.1Time-consistenteconomicvariables........................ 211 A.3.2 Missing values in PIA velha ............................ 213 A.3.3Rebasingtoacommoncurrency......................... 213 A.3.4 A comment on plant data in PIA velha ..................... 214 A.4DeflatingFlowVariables.................................. 214 A.4.1Correctingforignoredinflation.......................... 215 A.4.2 Price indices for 1986-1998 ............................ 216 A.4.3Priceindicesforoutputvariables......................... 217 A.4.4 Price indices for inputs of intermediate goods . .............. 217 A.4.5 Price indices for inputs other than intermediate goods . ....... 219 A.4.6Priceindicesforgrossinvestmentflows...................... 220 A.5DeflatingAssetsandtheConstructionofCapitalStockSeries............. 221 A.5.1Judgingconsistentcapitalstockseries...................... 222 A.5.2Governmentallyimposeddeflators........................ 223 A.5.3Stockvariables................................... 224 A.5.4Assetretirements.................................. 227 A.5.5 Optional revaluation of assets in 1991 . ..................... 227 A.5.6Correctionfactorsforassetfigures........................ 229 A.5.7Amethodsatisfyingconsistencycriteria..................... 231 A.5.8 Connecting