Comment of the Day: Sherman Robinson: On the Economics of BREXIT: “I largely agree with Simon Wren-Lewis’s comments, and with the quote from Maurice Obstfeld…

…The trade-productivity links they discuss, as Wren-Lewis notes, “all make common sense”.

However, I think it is very important to sort out the empirical relevance of the different causal mechanisms—it is impossible to consider policy choices without doing so. I see four mechanisms at work:

  1. Ricardian movement of factors to exploit comparative advantage from opening to international trade. Clearly true, but forty years of work with computable general equilibrium (CGE) models, both single-country and global, indicates that pure Ricardian effects on productivity are very small. In conferences, we often cite a “theorem” due to Arnold Harberger: “triangles” are smaller than rectangles”.

  2. “Winds of competition” or “challenge/response” models. There is a large literature on such models, all arguing that opening up markets to competition forces firms to move to the production frontier and/or induces investment in technological change. These effects appear to be significant.

  3. Explicit backward linkages between exporting and “learning better techniques”. These are also significant effects in particular cases, but would seem to be limited in coverage and probably not large enough to have much effect at the national/global levels.

  4. Fragmentation of production processes that allows strong specialization and regional diversification of production of intermediate inputs. There are many examples of these value chains across economic activities: agriculture, manufacturing, and services. They allow producers to achieve “Smithian” gains in productivity through fine specialization. They are seen by later stages in the value chain as lowering input costs, which are not measured as, say, a TFP gain by the later-stage producer, but is very significant. I think that these Smithian productivity gains are very large and cover a wide range of economic activity for countries that have taken part in value chains.

These four mechanisms are not mutually exclusive—all are operating and are probably very complementary. For a nice discussion of the empirical importance of fragmentation of value chains, see the new book by Ricard Baldwin: The Great Convergence. He argues, and I agree, that this fragmentation has been a major driver of trade-linked productivity growth.

On Brexit. The UK is embedded in the EU and most of its trade involves imports and exports of intermediate inputs in complex value chains, so mechanism (4) is very important. Policies that interrupt value chains will be very damaging. For example, if the UK leaves the EU customs union, then the EU will have to impose rules of origin conditions that will impede trade. Firms may well prefer to move operations to the EU in order to keep the value chains operating smoothly. There are lots of other issues concerning how to support and foster value chains, beyond the scope of a short comment.