Trade liberalization, democratization, and technology adoption

Abstract

A general equilibrium theory with heterogeneous skills predicts a complementarity between trade and democracy in creating demand for superior technologies. Trade liberalization or democratization alone may lead to vested interests that limit technology adoption. We use panel data on technology adoption, at a disaggregated level, for the period 1980–2000. Exploiting within-country variation over time and the heterogeneous timing of trade liberalization and democratization, we document a significant and sizable positive interaction between trade openness and democratization for technology adoption. The result that transitions to open democracies are beneficial for technological dynamics is robust to a large set of checks.

Appendix

1.1 Analytical derivations and proofs

Proof of Lemma 2

The Cobb–Douglas preferences in (1) together with equations (2)-(4) imply that the aggregate demand for each good is given by

$$\begin{aligned} p\int _{\underline{\theta }}^{\infty }\theta ^{A}dG(\theta )=\beta E, \end{aligned}$$

(12)

and

$$\begin{aligned} Z(L(\underline{\theta }),N)=\left( 1-\beta \right) E. \end{aligned}$$

(13)

where E denotes total expenditure.

In a closed economy the total demand for each good must be covered by internal production. The product market clears when (12) and (13) jointly hold, that is if, and only if,

$$\begin{aligned} p=\frac{\beta }{1-\beta } \frac{Z(L(\underline{\theta }),N)}{\int _{\underline{\theta }}^{\infty }\theta ^{A}dG(\theta )}. \end{aligned}$$

(14)

Recall that the labor market is in equilibrium at $\underline{\theta }$ if (5) and (4) jointly hold, which implies

$$\begin{aligned} p=\frac{w(L\left( \underline{\theta }\right) ,N)}{\underline{\theta }^{A}}. \end{aligned}$$

(15)

The product and the labor markets therefore clear at $\underline{\theta }$ if, and only if, (14) and (15) hold simultaneously, which implies

$$\begin{aligned} Z(L(\underline{\theta }),N)=\frac{1-\beta }{\beta }\frac{w(L\left( \underline{\theta }\right) ,N)}{\underline{\theta }^{A}}\int _{\underline{\theta } }^{\infty }\theta ^{A}dG(\theta ). \end{aligned}$$

(16)

Recall that, for any given $\underline{\theta }$, the share of workers in the traditional sector is

$$\begin{aligned} L(\underline{\theta }) =\int _{1}^{\underline{\theta }}g(\theta )d\theta =G( \underline{\theta }). \end{aligned}$$

(17)

Given $w(L(\underline{\theta }), N)L(\underline{\theta }) =\eta Z(L(\underline{\theta }),N)$ from (2), and using (17), the equilibrium condition (16) can be finally expressed as

$$\begin{aligned} G(\underline{\theta })\underline{\theta }^{A}=\eta \frac{1-\beta }{\beta }\int _{ \underline{\theta }}^{\infty }\theta ^{A}dG(\theta ). \end{aligned}$$

(18)

The equilibrium in a closed economy exists, is interior and is unique because:

• Looking at the limits: (i) When $\underline{\theta }=1$ the left-hand-side (LHS, henceforth) is zero as $G(1)=0$. The right-hand-side (RHS, henceforth) instead would be strictly positive as $\int _{1}^{\infty }\theta ^{A}dG(\theta )>0$. (ii) when $\underline{\theta }\rightarrow \infty$, the LHS is strictly positive, whereas the RHS goes to zero as $\int _{{\infty }}^{\infty }\theta ^{A}dG(\theta )=0$. Continuity of the functions insure the existence of at least one equilibrium since the two curves must intersect for a finite level of skill.

• The LHS of (18) is strictly increasing in $\underline{\theta }$, while the RHS is strictly decreasing in $\underline{\theta }$, which guarantees uniqueness.

Notice that this is also the case if the skill level is bounded as the same concept holds. Consider for instance a distribution of skills that is bounded from above at a level $\tilde{\theta }$. When evaluated in the limit case in which $\underline{\theta }=\tilde{\theta }$, the LHS of equation (20) equals $\tilde{\theta }^A>0$, while the RHS is still zero as $\int _{{\tilde{\theta }}}^{\tilde{\theta }}\theta ^{A}dG(\theta )=0$ $\square$

Proof of Lemma 3

Denoting by $\underline{\theta }$ the equilibrium threshold in a closed economy and rewriting the equilibrium condition (18), define

$$\begin{aligned} F(\underline{\theta },A)=G(\underline{\theta })k-\frac{\int _{\theta }^{\infty }\theta {}^{A}dG(\theta )}{\underline{\theta }^{A}}=0, \end{aligned}$$

(19)

where $k=\frac{1}{\eta }\frac{\beta }{1-\beta }$. To see the effect of an increase in A on $\underline{\theta }$ we use the implicit function theorem to get

$$\begin{aligned} \frac{\partial \underline{\theta }\left( A\right) }{\partial A}=-\frac{ \partial F(.)/\partial A}{\partial F(.)/\partial \underline{\theta }}=-\frac{ -\int _{\theta }^{\infty }\theta {}^{A}\left( \ln \theta -\ln \underline{\theta }\right) dG(\theta )/\underline{\theta }^{A}}{G^{\prime }(\theta )k-\frac{ \underline{\theta }^{A}\left( -\underline{\theta }^{A}\right) -A \underline{\theta }^{A-1}\int _{\theta }^{\infty }\theta {}^{A}dG(\theta )}{[\underline{\theta }^{A}]^{2}}}>0, \end{aligned}$$

(20)

because by Leibniz rule

$$\begin{aligned} \frac{\partial \int _{\theta }^{\infty }\theta {}^{A}dG(\theta )}{\partial \underline{\theta } }=-\underline{\theta }^{A}<0 \end{aligned}$$

and because $\partial L\left( \underline{\theta }\right) /\partial \underline{\theta }>0$.

The observation above also directly implies a reduction in the wage w in the traditional sector following an increase in A. The effect of an increase in A on the skill premium is given by

$$\begin{aligned} \frac{\partial \left( \theta ^{A}/\underline{\theta }\left( A\right) ^{A}\right) }{\partial A}=\left( \theta ^{A}/\underline{\theta }\left( A\right) ^{A}\right) [\ln \theta -\ln \underline{\theta }\left( A\right) \frac{\partial \underline{\theta } \left( A\right) }{\partial A}]. \end{aligned}$$

(21)

From (20) $\partial \underline{\theta }\left( A\right) /\partial A>0$ and because $\ln \theta$ is strictly monotonic in $\theta$, there exists a unique level of $\theta \equiv \overline{\theta }\left( A\right)$ above which (21) is positive.

The increase in the labor occupied in the traditional sector, Z, implies an increase in the total production in that sector. In principle the equilibrium production in the X sector may increase (due to A) or decrease (due to higher $\underline{\theta }$) depending on the sign of $d\left( \int _{\theta }^{\infty }\theta {}^{A}dG(\theta )\right) /dA$. But the equilibrium condition requires that the positive direct effect of a better technology A dominates and always increases total output in the X sector as well. This can be seen by considering again the condition for the equilibrium in a closed economy,

$$\begin{aligned} G(\underline{\theta })\underline{\theta }^{A}=\eta \frac{1-\beta }{\beta } \int _{\theta }^{\infty }\theta {}^{A}dG(\theta ). \end{aligned}$$

(22)

As shown above, a higher A increases $\underline{\theta }$, so the LHS of (22) is increasing in A, so that the RHS must also increase, which requires an increase in total production in the X sector: $d\left( \int _{\theta }^{\infty }\theta ^{A}dG(\theta )\right) /dA>0$. Finally, notice from (15) that the reduction in equilibrium wages w and the increase in the threshold level of skill $\underline{\theta }$ imply a reduction in p. $\square$

Proof of Lemma 4

The equilibrium in an open economy is implicitly characterized by (15) evaluated at the international prices $p=p^{*}$. That $\frac{\partial \underline{\theta }^{o }\left( A\right) }{\partial A}<0$ and, therefore, that the labor supply L and total production in Z decrease can be directly verified by looking at (15), (17), and the Cobb–Douglas production function for the traditional sector.

As p is fixed in this case, a higher A cannot be followed by an increase in $\underline{\theta }$ because this would make the denominator on the RHS increase further while it would necessarily decrease $w(L\left( \underline{\theta }\right) ,N)$ in the numerator, which would violate the equality. All the remaining results directly follow as in the proof of Lemma 3. One can conclude, since prices are fixed by world markets, that the effect of an increase in A monotonically decreases the utility of the elite and increases that of all workers. $\square$

Proof of Proposition 1

We need to characterize the change in attitude towards technological improvements by the part of the political rulers in an autocracy following a process of openness to trade. The total income of the elite, which is the residual claimant of the income produced in the Z sector, is given by $Y^{E}=(1-\eta )Z$, and by dividing it by the size of elite, denoted by $\sigma$, one gets the per-capita income of each member of the elite. From (10) each member of the elite strictly gains from an increase in the productivity A if, and only if, their real income increases. From Lemma 3, in a closed economy an increase in A increases the indirect utility of the elite because it increases Z and reduces the price p. From Lemma 4, however, Z decreases in response to higher A in an open economy (while $p=p^{*}$). In a closed economy, the elite benefits from technology adoption, whereas this is not true in an open economy. $\square$

Table 6 Summary statistics

Table 7 Within correlation matrices: different samples

Proof of Proposition 2

From Lemma 3 the nominal wage of workers in the traditional sector, w(L, N), decreases with a higher A in a closed economy. Under autarky, the workers in the traditional sector can gain from technological improvements if, and only if, the reduction of price p more than compensates the reduction in their nominal income. In turn, from (4), the nominal earnings of an individual with skill $\theta$ working in the modern sector are given by the base wage times the skill premium, $w(L,N)\left( \theta /\underline{\theta }\right) ^{A}$, that from Lemma 3 can be increasing only for the highly-skilled workers, for whom the increase in skill premium $\left( \theta /\underline{\theta }\right) ^{A}$ more than compensates the reduction in the base wage, w. Therefore, compared to a closed autocracy, the process of democratization strictly reduces the incentives for technology adoption if the new political ruler (the new pivotal voter) is a worker who loses from technology adoption (e.g., a less-skilled worker). The sign of the effect of technology adoption is unchanged if the new political ruler gains from technology adoption (e.g., a highly-skilled worker). $\square$

Proof of Proposition 3

Compared to an open autocracy, the emergence of an open democracy strictly increases the incentives to increase A since, from Lemma 4, in an open economy all workers (the new political rulers) gain from higher A, while the elite lose. Compared to a closed democracy, openness to trade (weakly) increases the incentives for technology adoption since (again from Lemma 4) all workers gain from higher A, while (from Lemma 3) in a closed democracy (only) the highly-skilled workers are (more) likely to gain from higher A. $\square$

1.2 Summary statistics and partial correlations

We report the summary statistics and the within correlations for the baseline samples of Technology Adoption (CHAT data) (Tables 6, 7).