Anthony J. Venables
Economic activity is unevenly distributed across space, both internationally and within countries. What determines this spatial distribution, and how is it shaped by trade? Classical trade theory gives the insights of comparative advantage and gains from trade but is firmly aspatial, modeling countries as points and trade (in goods and factors of production) as either perfectly frictionless or impossible. Modern theory places this in a spatial context in which geographical considerations influence the volume of trade between places. Gravity models tell us that distance is important, with each doubling of distance between places halving the volume of trade. Modeling the location decisions of firms gives a theory of location of activity based on factor costs (as in classical theory) and also on proximity to markets, proximity to suppliers, and the extent of competition in each market. It follows from this that—if there is a high degree of mobility—firms and economic activity as a whole may tend to cluster, providing an explanation of observed spatial unevenness. In some circumstances falling trade barriers may trigger the deindustrialization of some areas as activity clusters in fewer places. In other circumstances falling barriers may enable activity to spread out, reducing inequalities within and between countries. Research over the past several decades has established the mechanisms that cause these changes and placed them in full general equilibrium models of the economy. Empirical work has quantified many of the important relationships. However, geography and trade remains an area where progress is needed to develop robust tools that can be used to inform place-based policies (concerning trade, transport, infrastructure, and local economic development), particularly in view of the huge expenditures that such policies incur.
Sushant Acharya and Paolo Pesenti
Global policy spillovers can be defined as the effect of policy changes in one country on economic outcomes in other countries. The literature has mainly focused on monetary policy interdependencies and has identified three channels through which policy spillovers can materialize. The first is the expenditure-shifting channel—a monetary expansion in one country depreciates its currency, making its goods cheaper relative to those in other countries and shifting global demand toward domestic tradable goods. The second is the expenditure-changing channel—expansionary monetary policy in one country raises both domestic and foreign expenditure. The third is the financial spillovers channel—expansionary monetary policy in one country eases financial conditions in other economies. The literature generally finds that the net transmission effect is positive but small. However, estimated spillovers vary widely across countries and over time. In the aftermath of the Great Recession, the policy debate has devoted special attention to the possibility that the magnitude and sign of international spillovers might have changed in an environment of low interest rates worldwide, as the expenditure-shifting channel becomes more relevant when the effective lower bound reduces the effectiveness of conventional monetary policies.
Home bias in international macroeconomics refers to the fact that investors around the world tend to allocate majority of their portfolios into domestic assets, despite the potential benefits to be had from international diversification. This phenomenon has been occurring across countries, over time, and across equity or bond portfolios. The bias towards domestic assets tends to be larger in developing countries relative to developed economies, with Europe characterized by the lowest equity home bias, while Central and South America—by the highest equity home bias. In addition, despite the secular decline in the level of equity home bias over time in all countries and regions, home bias still remains a robust feature of the data.
Whether home bias is a puzzle depends on the portfolio allocation that one uses as a theoretical benchmark. For instance, home bias in equity portfolio is a puzzle when assessed through the lens of a simple international capital asset pricing model (CAPM) with homogeneous investors. This model predicts that investors should hold world market portfolios, namely a portfolio with the share of domestic asset equal to the share of those assets in the world market portfolio. For instance, since the share of US equity in the world capitalization in 2016 was 56%, then US investors should allocate 56% of their equity portfolio into local assets, while investing the remaining 44% into foreign equities. Instead, foreign equity comprised just 23% of US equity portfolio in 2016, hence the equity home bias.
Alternative portfolio benchmark comes from the theories that emphasize costs for trading assets in international financial markets. These include transaction and information costs, differential tax treatments, and more broadly, differences in institutional environments. This research, however, has so far been unable to reach a consensus on the explanatory power of such costs.
Yet another theory argues that equity home bias can arise due to the hedging properties of local equity. In particular, local equity can provide insurance from real exchange rate risk and non-tradable income risk (such as labor income risk), and thus a preference towards home equities is not a puzzle, but rather an optimal response to such risks.
These theories, main advances and results in the macroeconomic literature on home bias are discussed in this article. It starts by presenting some empirical facts on the extent and dynamics of equity home bias in developed and developing countries. It is then shown how home bias can arise as an equilibrium outcome of the hedging demand in the model with real exchange rate and non-tradable labor income risk. Since solving models with portfolio choice is challenging, the recent advances in solving such models are also outlined in this article.
Integrating the portfolio dynamics into models that can generate realistic asset price and exchange rate dynamics remains a fruitful avenue for future research. A discussion of additional open questions in this research agenda and suggestions for further readings are also provided.
Eduardo A. Cavallo
Sudden stops in capital flows are a form of financial whiplash that creates instability and crises in the affected economies. Sudden stops in net capital flows trigger current account reversals as countries that were borrowing on net from the rest of the world before the stop can no longer finance current account deficits. Sudden stops in gross capital flows are associated with financial instability, especially when the gross flows are dominated by volatile cross-border banking flows. Sudden stops in gross and net capital flows are episodes with an external trigger. This implies that the spark that ignites sudden stops originates outside the affected country: more specifically, in the supply of foreign financing that can halt for reasons that may be unrelated to the affected country’s domestic conditions. Yet a spark cannot generate a fire unless combustible materials are around. The literature has established that a set of domestic macroeconomic fundamentals are the combustible materials that make some countries more vulnerable than others. Higher fiscal deficits, larger current account deficits, and higher levels of foreign currency debts in the domestic financial system are manifestations of weak fundamentals that increase vulnerability. Those same factors increase the costs in terms of output losses when the crisis materializes. On the flip side, international reserves provide buffers that can help countries offset the risks. Holding foreign currency reserves hedges the fiscal position of the government providing it with more resources to respond to the crisis. While it may be impossible for countries to completely insulate themselves from the volatility of capital inflows, the choice of antidotes to prevent that volatility from forcing potentially costly external adjustments is in their own hands. The global financial architecture can be improved to support those efforts if countries could agree on and fund a more powerful international lender of last resort that resembles, at the global scale, the role of the Federal Reserve Bank in promoting financial stability in the United States.
While economists overwhelmingly favor free trade, even unilateral free trade, because of the gains realizable from specialization and the exploitation of comparative advantage, in fact international trading relations are structured by a complex body of multilateral and preferential trade agreements. The article outlines the case for multilateral trade agreements and the non-discrimination principle that they embody, in the form of both the Most Favored Nation principle and the National Treatment principle, where non-discrimination has been widely advocated as supporting both geopolitical goals (reducing economic factionalism) and economic goals (ensuring the full play of theories of comparative advantage undistorted by discriminatory trade treatment).
Despite the virtues of multilateral trade agreements, preferential trade agreements (PTAs), authorized from the outset under GATT, have proliferated in recent years, even though they are inherently discriminatory between members and non-members, provoking vigorous debates as to whether (a) PTAs are trade-creating or trade-diverting; (b) whether they increase transaction costs in international trade; and (c) whether they undermine the future course of multilateral trade liberalization.
A further and similarly contentious derogation from the principle of non-discrimination under the multilateral system is Special and Differential Treatment for developing countries, where since the mid-1950s developing countries have been given much greater latitude than developed countries to engage in trade protectionism on the import side in order to promote infant industries, and since the mid-1960s on the export side have benefited from non-reciprocal trade concessions by developed countries on products of actual or potential export interest to developing countries.
Beyond debates over the strengths and weaknesses of multilateral trade agreements and the two major derogations therefrom, further debates surround the appropriate scope of trade agreements, and in particular the expansion of their scope in recent decades to address divergences or incompatibilities across a wide range of domestic regulatory and related policies that arguably create frictions in cross-border trade and investment and hence constitute an impediment to it.
The article goes on to consider contemporary fair trade versus free trade debates, including concerns over trade deficits, currency manipulation, export subsidies, misappropriation of intellectual property rights, and lax labor or environmental standards. The article concludes with a consideration of the case for a larger scope for plurilateral trade agreements internationally, and for a larger scope for active labor market policies domestically to mitigate transition costs from trade.
The rise in obesity and other food-related chronic diseases has prompted public-health officials of local communities, national governments, and international institutions to pay attention to the regulation of food supply and consumer behavior. A wide range of policy interventions has been proposed and tested since the early 21st century in various countries. The most prominent are food taxation, health education, nutritional labeling, behavioral interventions at point-of-decision, advertising, and regulations of food quality and trade. While the standard neoclassical approach to consumer rationality provides limited arguments in favor of public regulations, the recent development of behavioral economics research extends the scope of regulation to many marketing practices of the food industry. In addition, behavioral economics provides arguments in favor of taxation, easy-to-use front-of-pack labels, and the use of nudges for altering consumer choices. A selective but careful review of the empirical literature on taxation, labeling, and nudges suggests that a policy mixing these tools may produce some health benefits. More specifically, soft-drink taxation, front-of-pack labeling policies, regulations of marketing practices, and eating nudges based on affect or behavior manipulations are often effective methods for reducing unhealthy eating.
The economic research faces important challenges. First, the lack of a proper control group and exogenous sources of variations in policy variables make evaluation very difficult. Identification is challenging as well, with data covering short time periods over which markets are observed around slowly moving equilibrium. In addition, truly exogenous supply or demand shocks are rare events. Second, structural models of consumer choices cannot provide accurate assessment of the welfare benefits of public policies because they consider perfectly rational agents and often ignore the dynamic aspects of food decisions, especially consumer concerns over health. Being able to obtain better welfare evaluation of policies is a priority. Third, there is a lack of research on the food industry response to public policies. Some studies implement empirical industrial organization models to infer the industry strategic reactions from market data. A fruitful avenue is to extend this approach to analyze other key dimensions of industrial strategies, especially decisions regarding the nutritional quality of food. Finally, the implementation of nutritional policies yields systemic consequences that may be underestimated. They give rise to conflicts between public health and trade objectives and alter the business models of the food sector. This may greatly limit the external validity of ex-ante empirical approaches. Future works may benefit from household-, firm-, and product-level data collected in rapidly developing economies where food markets are characterized by rapid transitions, the supply is often more volatile, and exogenous shocks occur more frequently.
Fabrice Etilé and Lisa Oberlander
In the last several decades obesity rates have risen significantly. In 2014, 10.8% and 14.9% of the world’s men and women, respectively, were obese as compared with 3.2% and 6.4% in 1975. The obesity “epidemic” has spread from high-income countries to emerging and developing ones in every region of the world. The rising obesity rates are essentially explained by a rise in total calorie intake associated with long-term global changes in the food supply. Food has become more abundant, available, and cheaper, but food affluence is associated with profound changes in the nutritional quality of supply. While calories have become richer in fats, sugar, and sodium, they are now lower in fiber. The nutrition transition from starvation to abundance and high-fat/sugar/salt food is thus accompanied by an epidemiological transition from infectious diseases and premature death to chronic diseases and longer lives. Food-related chronic diseases have important economic consequences in terms of human capital and medical care costs borne by public and private insurances and health systems.
Technological innovations, trade globalization, and retailing expansion are associated with these substantial changes in the quantity and quality of food supply and diet in developed as well as in emerging and rapidly growing economies. Food variety has significantly increased due to innovations in the food production process. Raw food is broken down to obtain elementary substances that are subsequently assembled for producing final food products. This new approach, as well as improvements in cold chain and packaging, has contributed to a globalization of food chains and spurred an increase of trade in food products, which, jointly with foreign direct investments, alters the domestic food supply. Finally, technological advancements have also favored the emergence of large supermarkets and retailers, which have transformed the industrial organization of consumer markets.
How do these developments affect population diets and diet-related diseases? Identifying the contribution of supply factors to long-term changes in diet and obesity is important because it can help to design innovative, effective, and evidence-based policies, such as regulations on trade, retailing, and quality or incentives for product reformulation. Yet this requires a correct evaluation of the importance and causal effects of supply-side factors on the obesity pandemic. Among others, the economic literature analyzes the effect of changes in food prices, food availability, trade, and marketing on the nutrition and epidemiological transitions. There is a lack of causal robust evidence on their long-term effects. The empirical identification of causal effects is de facto challenging because the dynamics of food supply is partly driven by demand-side factors and dynamics, like a growing female labor force, habit formation, and the social dynamics of preferences.
There are several important limitations to the literature from the early 21st century. Existing studies cover mostly well-developed countries, use static economic and econometric specifications, and employ data that cover short periods of time unmarked by profound shifts in food supply. In contrast, empirical research on the long-term dynamics of consumer behavior is much more limited, and comparative studies across diverse cultural and institutional backgrounds are almost nonexistent. Studies on consumers in emerging countries could exploit the rapid time changes and large spatial heterogeneity, both to identify the causal impacts of shocks on supply factors and to document how local culture and institutions shape diet and nutritional outcomes.