SIPANEWS - Columbia University In The City Of New York

JANUARY 2009SIPANEWSTHE LATINAMERICA ISSUEr2e5239A CS3.indd a1/8/09 11:33:51 PM

contentsINSIDE SIPAFEATURESp. 2p.12p.24p. 38p. 42How Will LatinAmerica Fare in theGlobal Recession?Quality Upgradingand Wage Inequality inMexicoBy Thomas J. TrebatBy Eric VerhoogenThe Whole Bean:Guatemalan CoopClaims Fair CoffeeProduction Process—Not Just Fair TradeAfter ControversialExpulsions, EvoMorales Defends HisPoliciesBy Jamie HolmesBrazilianPhilanthropistDonates 3 Millionfor StudentExchangesp. 39p. 42Mexico City on theMoveJulius G. Blocker,MIA ’56, Donates 3.5 Million forExchange Programp. 6p.15By Gwyneth FriesLatin America GetsHeated: TensionsRise as RegionalClimate WarmsBranding Peace inBrazilp. 28By Massimo AlpianCuba Policy for a NewU.S. AdministrationBy Sasha Chavkinp.18By Dóra Beszterczeyp. 9p. 32Migration: No CountryIs an IslandEducation in LatinAmerica: GreatAchievements andEven Greater DeficitsBy Caroline StaufferBy Miguel Urquiolap. 11p.20Factories as aSolution? DominicanPresident Weighs inon Haitian MigrationRightsPushing for PeaceBy Eamon Kircher-Allenr2e5239A CS3.indd Sec2:1By Jake Rollow and DanGreenThe PostrevolutionaryGeneration: Findinga Space for YouthActivism in RaúlCastro’s CubaBy Rebecca Rousep. 34A Comeback forInflation?By Eamon Kircher-Allenp. 40The SIPA AlumniCouncil SetsPriorities for2008–2009p. 42p. 43Class Notes Fall2008p. 49Donor ListNew FellowshipProgram for New YorkCity EmployeesBy Mariano Castillo1/8/09 11:33:52 PM

QUALITY UPGRADINGA worker at VW’s Puebla plant assembles one of the finaleditions of the original Beetle on July 11, 2003. Theoriginal Beetle went out of production in 2003 after beingavailable for almost 70 years.1 2 S I PA N E W Sr2e5239A CS3.indd Sec2:121/8/09 11:33:53 PM

ANDWAGE INEQUALITYIN MEXICOBy Eric VerhoogenThe wave of optimism aboutinternational integration thataccompanied the signing ofthe North American FreeTrade Agreement (NAFTA)in Mexico and other tradeagreements across LatinAmerica has been receding. In part, this disappointment derives from a widespread perception that international integration exacerbatesincome inequality and social polarization. In arecent review article in the Journal of EconomicLiterature, Penelopi Goldberg of Princeton andNina Pavcnik of Dartmouth have found that thisperception is based in fact: opening to trade hasconsistently been accompanied by rising incomeinequality in developing countries.1The coincidence of expanding trade and risingwage inequality in developing countries fits awkwardly into economists’ standard trade models.The simplest version of the most common model,called the Heckscher-Ohlin model, predicts thatwage inequality will fall in poor countries thatintegrate with rich ones, as they specialize in producing goods that require a high proportion oflow-skilled workers, thereby increasing demandfor such workers. A common reaction amongeconomists has been to argue that rising inequality is likely due to factors that have little to dowith trade, like technological change. In a recentwork, I have advanced an alternative hypothesislinking trade and wage inequality in developingcountries through the product-quality decisionsof manufacturing plants.2 Let me explain the ideausing the example of a particularly well-knownplant, the Volkswagen plant in Puebla, Mexico.The VW-Puebla plant was established in 1964,mainly to sell to the Mexican domestic market,which was largely closed to automobile imports.Over time, the company also started producingfor export at the plant, and for many years thePuebla plant was the company’s only plant inNorth America, with primary responsibility for theU.S. as well as the Mexican market. In the early1990s, it produced the Jetta and the Golf, mainlyfor export, as well as the original Beetle, known inMexico as the Sedan or, more affectionately, theVochito, mainly for the domestic market. Whenthe company introduced the New Beetle in 1998aimed at the U.S. market, the Puebla plant becamethe sole world producer. There are marked differences in quality between the original Beetle and thenewer exported models, the New Beetle and Jetta.The New Beetle and Jetta have automatic windowraising mechanisms; the windows of the originalBeetle had to be cranked up by hand. The seats ofthe New Beetle and Jetta consist of polyurethanefoam; the seats of the original Beetle were madepartly of lower-quality foam and partly of coconutfibers, a cheaper substitute. The quality differences are reflected in the prices of the models: inJuly 2003, when production of the original Beetleceased, the New Beetle and the Jetta were sellingfor approximately US 17,750 and US 15,000 inboth countries; the original Beetle was selling forapproximately US 7,500 in Mexico.Perhaps the most remarkable feature of theplant, until production of the original Beetle wasdiscontinued in 2003, was the juxtaposition ofthe production lines for the New Beetle and Jetta,which relied on state-of-the-art technology, andthe production line for the original Beetle, whichemployed essentially the same technology thathad been transplanted from Germany in 1964,technology that dated back to the 1950s. WhenI visited in May 2003, for instance, the conveyorbelt in the welding area on the original Beetleline had been in continuous operation since 1967.The welding was done by hand, with sparks flying, and line-workers banged irregularities intoshape with mallets. Under the same roof, perhapstwenty yards away, the welding for the Jettabody was performed entirely by robots. The onlyworkers in the area (and then only occasionally)were engineers to program the robots and skilledmaintenance workers to repair the machines incase of mechanical failure. The line-workers onthe original Beetle were mainly in the categoryof técnicos (technicians), who had a starting wageof about 11 per day. The skilled maintenanceworkers on the Jetta and New Beetle lines weremainly classified as especialistas (specialists), with astarting wage of about 18 per day.Now consider the effects of increased tradeon product quality at the VW-Puebla plant. It iscommon in the trade economics literature to usechanges in tariffs—for instance under NAFTA—to examine the effects of increased trade. Butin my work I have mainly used the massiveexchange rate devaluation of December 1994 andthe ensuing recession—the peso crisis—becausethe enormity of the shock makes it easier to tracethe effects. The accompanying figure illustratesthe effect of the peso crisis on the mix of carmodels produced in the plant. Between 1994and 1995, exports as a share of total productionrose sharply, due both to a decline in domesticsales and to an increase in exported cars, which,S I PA N E W S 1 3r2e5239A CS3.indd Sec2:131/8/09 11:33:53 PM

The coincidence ofexpanding trade andrising wage inequality indeveloping countriesfits awkwardly intoeconomists’ standardtrade models.because of the decline in the real value of thepeso, were relatively cheap to produce in dollarterms. Domestic production was mostly of original Beetles, and export production was mainly ofJettas and Golfs (and, later, New Beetles). So theincrease in the export share also entailed a sharpincrease in production of the higher-quality models as a share of output, a process I have referredto as quality upgrading.This shift toward sales of higher-qualitymodels also meant a greater reliance on moreadvanced technologies on the Jetta, Golf andNew Beetle lines. Although I was not able to persuade the company to share detailed personneldata, it also appears from conversations with theformer human resources director and the head ofthe union at the plant that demand for especialistasrose relative to técnicos, and demand for softwareengineers rose relative to less-specialized supervisors on the original Beetle line.Generalizing from the VW example, it appearsthat this mechanism contributed to an overallincrease in the demand for skill in Mexico, raising overall wage inequality. There was a secondeffect, which requires some explanation. Withineach industry in Mexico, only the most modern,productive, technologically sophisticated plants,usually fewer than 20 percent of plants in anindustry, are able to export profitably. Theseplants also tend to employ the most skilled peoplewithin occupational categories and to pay highwages relative to other plants in the industry. Thepeso crisis hit the solely domestic-oriented plantsharder than the export-oriented plants, and wagesfell more in the domestic-oriented plants, whichalready tended to be lower wage. This tended toincrease the dispersion of wages in the manufacturing sector and to raise inequality overall.So is increased international integration agood thing? The verdict is mixed. On the onehand, quality upgrading may boost the rate oflearning and improve productivity while generating good jobs. On the other hand, it may increaseinequality, which in turn, strains the social fabric.There are relative winners and losers from tradeliberalization—different from the ones suggestedby economists’ traditional trade models. Manyof the poorest and least skilled in developingcountries view globalization with pessimism. Thisresearch suggests that their concerns may makeeconomic sense after all.1. See Goldberg and Pavcnik (2007).2. See Verhoogen (2008).ReferencesDavis, Bob, John Lyons, and Andrew Batson (2007).“Globalization’s Gains Come with a Price.” The Wall StreetJournal (May 24), 1.Goldberg, Penelopi Koujianou, and Nina Pavcnik (2007).“Distributional Effects of Globalization in DevelopingCountries.” Journal of Economic Literature 45 (1) (March),39–82.Hanson, Gordon, and Helen Shapiro (1994). “Volkswagende Mexico’s North American Strategy.” Harvard BusinessSchool Case No. 9-794-104.Verhoogen, Eric. “Trade, Quality Upgrading and WageInequality in the Mexican Manufacturing Sector ” (2008).Quarterly Journal of Economics 123 (2), 489–530.Eric Verhoogen is assistant professor of International andPublic Affairs and of Economics at Columbia University’sSchool of International and Public Affairs.1 4 S I PA N E W Sr2e5239A CS3.indd Sec2:141/8/09 11:33:53 PM

the company introduced the New Beetle in 1998 aimed at the U.S. market, the Puebla plant became the sole world producer. There are marked differ-ences in quality between the original Beetle and the newer exported models, the New Beetle and Jetta. The New Beetle and Jetta have automatic window-raising mechanisms; the windows of the original