Academic journal article Economic Inquiry

Welfare and Public Policy: The Role of Internationalized Production

Academic journal article Economic Inquiry

Welfare and Public Policy: The Role of Internationalized Production

Article excerpt

I. INTRODUCTION

Micro foundations of the "new open macroeconomics" framework (see Lane 2001 for a comprehensive survey) provide a well-grounded welfare criterion to evaluate public policies. Contributions in this line of research suggest that whether a monetary or a fiscal innovation is detrimental or beneficial in terms of national welfare depends on various characteristics of the world economy under consideration. (1) The complexity of this problem warrants further investigation on economic features along this line of research to sort out policy implications. In this article I focus on a prevalent feature of the real world--firms hiring both domestic and foreign production factors to produce national goods--and call it internationalized production. (2)

Production factors contribute to foreign production through various ways of globalized production processes. For instance, a country can utilize foreign factors through importing intermediate goods, and firms can directly hire foreign production factors through establishing foreign-owned firms and foreign direct investment abroad. (3) The extent of internationalized production is not easy to measure, however, yet empirical evidence indicates that its scale and importance have been on the rise in recent years for many countries. Table 1 shows the imported inputs as a share of the value of production for selected countries, computed by Campa and Goldberg (1997). In all the four countries, except Japan, the shares of imported inputs have increased considerably in the last two decades.

Hummels et al. (1998) consider the imported inputs that are used to manufacture goods for export. They call the trade of these inputs vertical trade. Table 2 summarizes some of their results. Although vertical trade accounts for a relatively small fraction of total trade (as shown in the second and the third columns), its contribution to total export growth (as shown in the fifth column) far exceeds its share of total trade in all countries except Japan, indicating its increasing importance. In particular, for Canada and the Netherlands, almost 50% of the growth of exports from the first to the last year in the sample are due to growth in vertical trade.

Table 3, taken from Jungnickel and Keller (2003), presents the scales of sales and employment of foreign-owned firms in selected countries and years. In the listed countries, the sales and employment in percentage of the respective values for total manufacturing increase from 1985 to 1998, except in Japan and Italy (the figures for Germany are quite stable over time). In particular, foreign-owned firms employed more than a quarter of the total employment in the manufacturing sectors of France and Belgium in the year 1998.

As demonstrated, the factor markets have been increasingly connected across borders in production, and it is therefore important to investigate the implications of public policies to the world economy in which internationalized production matters. In this article I incorporate internationalized production into the model of Corsetti and Pesenti (2001), denoted CP hereafter, and investigate its role played on the welfare effects of public policies. This model generates many welfare implications different from CP's. In particular, an expansionary monetary shock can be beggar-thy-neighbor, and a fiscal shock can improve national welfare in this model. The ranges of parameter values which give rise to different welfare outcomes are derived. I also derive the transmission mechanism of public policy, which is quite different from theirs. In particular, in this model a fiscal shock affects the exchange rate and produces long-run welfare effects even if it is temporary. It is shown that internationalized production may not only cause tensions between countries but also widen the welfare gap between citizens in a country. This opens up a discussion on the issues of international retaliation and coordination, which I will discuss in the concluding remarks. …

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