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Abstract
Over the last decade there has been increasing international pressure on countries to raise ‘social standards’ (i.e. production standards based on environmental and labor conditions). Currently, the World Trade Organization does not allow countries to impose minimum standards on imports based on environmental or labor standards because it is assumed to undermine competition. There is no consensus in the empirical literature, however, to support this claim. In fact, the evidence suggests that while stronger environmental standards hurt competitiveness, stronger labor standards do the opposite. This paper offers one possible explanation for this paradox. In a simple model of incomplete information, externally imposed standards may either increase or decrease the competitiveness of infant firms from developing countries depending on the degree of complementarity between the standard and the production of high-quality goods.
Notes
1. This is not to say that the WTO does not support fundamental labor standards. In fact, the WTO confirmed its support for international labor standards at the Singapore ministerial conference of 1996 (Doumbia-Henry and Gravel Citation2006). Their position is that the establishment and enforcement of such standards is the role of the ILO. Nevertheless, the issue regarding the extent to which standards based on PPMs unduly harms competition is still controversial.
2. Under the General Agreement on Tariffs and Trade 1994, member countries are prohibited from enacting standards with respect to PPMs that discriminate against exports from another country in favor of ‘like products’ from either domestic sources or exports of a third country. Such restrictions are also covered under the Technical Barriers to Trade agreement (Beaulieu and Gaisford Citation2002). While exceptions may exist (e.g. Article XX of the GATT), it is clear that it is the intent of the WTO to prohibit disguised protectionism.
3. The literature on labor standards and exports is sparse because of the difficulty in measuring standards. Until recently, most studies were forced to use ratifications of ILO conventions as a proxy for adherence to labor standards. This measure has obvious flaws since it does not measure enforcement. Only recently has there been an attempt to measure enforcement (see Kucera and Sarna Citation2006).
4. See Ulph (Citation1999) for an overview of this literature.
5. See Leland (Citation1979), Shapiro (Citation1983), Shapiro (Citation1986) and Ronnen (Citation1991).
6. For other models that rely on a similar framework, see Mayer (Citation1984), Bagwell and Staiger (Citation1989), Bagwell (Citation1991), Chen (Citation1991), Skeath (Citation1995), Chisik (Citation2003) and Das and DeLoach (Citation2003).
7. For example, US imports from Asian and Pacific countries (excluding Japan, Australia and New Zealand) are now dominated by goods such as beverages, manufactures, apparel, cosmetics and pharmaceuticals. Using data from the US Department of Commerce (Citation2008), we estimate that between 1990 and 2005 alone, the share of all Asian exports to the US that are experience goods has risen from 38% to 58%.
8. For tractability of the model, we have eliminated the possibility that Northern firms can outsource production of their name-brand goods to the South. Implicitly, our model assumes such activities do not eliminate the problem faced by infant firms in the South. This is not entirely unreasonable. Quality and reputation are clearly valued even in the production of outsourced goods. In such cases, the ‘consumer’ in the North is actually the Northern firm that imports the goods and resells them under their own brand name. Consequently, consistent with the assumptions of the present model, fly-by-night firms from the South will not be able to meet the quality demanded by Northern brand name retailers in the long run.
9. There could be a number of possible reasons for this. It could simply be an effort to protect its industries from Southern competition. Or, it could be a welfare-maximizing decision. For example, if consumption of the good produces a transboundary negative externality (e.g. pollution), it would be welfare-improving to impose some sort of regulation on imports from the South.
10. Obviously LDCs value social standards. For example, India has worked for years to eliminate child labor. PROGRESA (now called Oportunidades) is a major program of the Mexican government aimed at reducing problems like malnutrition, morbidity, school dropout rates and unhealthy living conditions. Moreover, it is clearly not the case that all labor and environmental standards are imposed by developed countries. Nevertheless, it is true that many developed countries want to impose even tougher standards on their less-developed counterparts. That alone justifies the strong assumption maintained in this model.
11. This allows for moral hazard in the firm's choice of quality, while the heterogeneity across firms in the cost of providing quality effectively introduces adverse selection.
12. This assumption is consistent with the Grossman and Horn (Citation1988) set-up. This assumption rules out the possibility of moral hazard in the second period of the model. In a finite period model, all agents face a moral hazard problem. In this model, without this assumption, all reputable firms that survived the first period would clearly ‘cheat’ and produce low-quality goods once they have established their reputation for quality.
13. This is analogous to ISO 9000 quality standards, whereby any firms that do not adhere to this minimum standard cannot engage in international trade.
14. We have ruled out performance uncertainty and quality randomness in production.
15. For example, firms that fail to meet ISO 9000 standards would obviously have difficulty competing with firms that do meet these minimum quality standards. But firms that fail to meet PPM standards could well have an advantage since their costs are lower.
16. Following Grossman and Horn (Citation1988), Chen (Citation1991) and Skeath (Citation1995) we assume that consumers have rational expectations of quality. This rules out arbitrary pessimistic expectations that would eliminate low quality producers in the first period.
17. From the point of view of a policy maker in the South, this is inefficient. The best policy, of course, would be to find a way to provide international consumers with perfect information about the quality of goods produced from this country. Barring that, policy makers would prefer to find a way to provide incentives to productive firms to choose high quality and limit entry of those less productive, low quality firms. However, the Southern policy makers do not have the necessary information to do this. Historically, indiscriminate protection of all infant industries has not been successful without the ability to reward the high quality producers and punish the low quality producers. However, this is not possible under incomplete information.