# Describe ways in which economists measure the degree of financial market

integration

Abraham Lincoln once said: “I don’t know much about the tariff, but I know this. If I

buy a coat in England, I get the coat and England gets the money. If I buy a coat in America, I get

the coat and America gets the money.” From an economics perspective, what is wrong about

this idea of restricting international trade in order to rely more on national production?

2. Kept within sustainable bounds, trade deficits are not considered harmful by

international economists. Why? To answer, define the trade balance equation of a country, and

explain the economic justification of a country’s trade deficit. (Hint: use the current account

algebra to justify your answer).

3. Describe two ways in which economists measure the degree of financial market

integration. Provide a brief explanation for their use.

4. Define the two waves of globalization. Explain three factors that played a key role in

determining the first wave of globalization. What factors have influenced the second wave of

globalization?

## Trade Protection

The demand for spark plugs in the United States is given by Q = 100-P, where Q indicates the

number of spark plugs purchased and P is the price. Suppose that there are no spark plugs

produced in the U.S., but they can be imported from either Mexico or the rest of the world (ROW).

The price of spark plugs in Mexico is $20, and the price from the lowest cost supplier is $10. In each

case, spark plugs are produced with a horizontal supply curve, so that these prices are fixed and

will not change with changes in the U.S. policy. The U.S. tariff on spark plugs is a specific tariff in the

amount of $15 per unit imported.

5. If there is no free trade agreement between any countries, so that every country

must pay the same tariff, from where will U.S. consumers import their spark plugs: Mexico or

ROW? Compute the equilibrium price of spark plugs in the U.S., the quantity imported and

consumed, and the U.S. consumer surplus and tariff revenue.

6. Now, suppose the US signs a free trade agreement with Mexico that eliminates the

tariff on spark plugs from Mexico, but leaves the tariff on sparks plugs from ROW unchanged.

How will the equilibrium change? Answer the same questions as in the previous question under

this new policy regime

### Identify the welfare change due to trade creation and the welfare change due to trade diversion. Does the free trade agreement raise or lower U.S. welfare?

8. (10 points) Now, how would your answer to question (7) change if the tariff had been $50?

Explain using the necessary calculations for trade creation and trade diversion.

9. (5 points) Now, how would your answer change if the tariff had been $5? No calculation is

needed.

**Part C: Reading **

Read the attached article “Sense and Nonsense in the Globalization Debate” by Dani Rodrik, and

answer the following questions:

10. The article provides evidence of a direct relationship between the growth of trade

and the growth of government. What is the explanation behind this empirical finding? Also,

what is the challenge that governments face in accumulating more revenue to the treasury?

11. Explain the following statement: “trade exerts pressure towards another kind of

arbitrage as well: arbitrage in national norms and social institutions.” (p. 27). Why are

differences in national practices and institutions a possible source of comparative advantage?

12. The article mentions several misconceptions about trade and globalization. Name

and briefly explain three of these misconceptions.

#### Analyze the impact of NAFTA on U.S. workers in the short run

At

the time NAFTA went into effect, U.S. import tariffs for goods coming from Mexico fell to zero. You

will be using the drop in tariff levels (d_tariff) across manufacturing industries to measure the degree of

trade liberalization experienced by particular manufacturing industries in the U.S. You will correlate

these tariff changes to employment changes (d_employment) in those respective industries over the period

1990-2000.

The dataset that you will use for this empirical exercise is posted on Canvas and is called “nafta.dta”. A

description of the dataset is provided at the end of this assignment. You can use STATA, R or any other

statistical package you are familiar with to answer the questions below. When submitting your answers,

please make sure to attach a copy of your code/do-file and a copy of your log file or R output (all in one

pdf document that includes your homework answers).

##### Using the available dataset, please answer the following questions:

13. (5 points) Create a histogram of the change in U.S. import tariffs for goods coming from Mexico.

Identify and report the top 5 industries with the largest tariff cuts following NAFTA.

14. (3 points) Construct the natural log variables for the following industry characteristics in the dataset:

i) industry size (call this variable “ln_indsize”); ii) real value added (call this variable “ln_rvadd”); iii)

skill intensity (call this variable “ln_skill_intensity”); iv) capital-to-labor ration (call this variable

“ln_kl_ratio”).

15. (10 points) Estimate the following regression model:

Created in Master PDF Editor

Prof. Anca Cristea EC 482/582

Fall 2021

DLn(Employment)ik = b0 + b1 DLn(Tariff)k + b2 Ln(Industry_Size)k +

+ b3 Ln(RealValueAdded)k + b4 Ln(Skill_Intensity)k + b5 Ln(K/L)k + eik

where subscript i denotes a metropolitan area in the U.S. and subscript k denotes the manufacturing

industry (SIC 4-digit level). Implement robust standard errors to account for heteroskedasticity.

16. (5 points) Report the estimation results in a nicely formatted table with the independent variable

coefficients reported by row and the dependent variable listed at the top of the column (as in this

sample table). List the standard errors in parentheses below the regression coefficients. Mark with **

the coefficients that are statistically significant at 5 percent confidence level.

17. (5 points) Interpret the coefficient b1 for DLn(Tariff)k. What is the effect of a 1 percent drop in import

tariffs on labor employment in a given metropolitan area? Is the sign of the coefficient as expected?

Justify your answer.

18. (5 points) Construct an interaction variable between the (natural log) industry tariff change and the

(natural log) skill intensity of the industry. Call this variable “dln_tariff_skill”. Re-estimate the

regression model from question 15 by adding this interaction variable to the rest of the right-hand side

variables. Report the regression coefficients in a nicely formatted table as done for question 2.

19. (7 points) The (natural log) median skill intensity among the manufacturing industries in the sample is

-1.354. The top quartile industry has a skill intensity level of -1.039. The bottom quartile industry has

a skill intensity level of -1.585 (Note: you can verify these sample statistics for your own

information). Using these sample statistics for skill intensity, explain what is the effect on industry

labor employment of a 1% fall in import tariffs in an industry with the median level of skill intensity?

What is the effect for an industry at the top quartile of skill intensity? How about the bottom quartile

of skill intensity? Justify all your answers.

(Hint: No need to estimate any additional regressions to answer these questions. You will need to use

the regression coefficients from question 19 and the sample statistics given here).

20. (10 points) The signing of NAFTA triggered lots of conflicting policy debates about the labor market

implications of signing a free trade agreement with a low wage country like Mexico. Based on your

data analysis for this exercise, what can you conclude about this important policy debate? Has the

agreement been detrimental to workers? Does your answer differ depending on the skill level of

workers? If you were an economic adviser to the U.S. government, would you recommend the

signing on NAFTA based on your regression estimations? Briefly explain your answers