Psychology and International Trade with Heterogeneous Managers

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Psychology and International Trade with
Heterogeneous Managers

• M. Blanchard and F. PeltraultINALCO and
  University Paris Dauphine
• EURIsCO

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European Commission  Europe suffers from an
entrepreneurship deficit in comparison to the US

• The level of entrepreneurship differs across
  countries
• Psychology of managers can explain these
  differences
• The purpose of this paper is to challenge the
  link between the psychology of managers,
  entrepreneurship and international trade

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Modelling the psychology of managers

• Kahneman and Tversky and Psychologists show that
  managers distort objective probability
• Managers can be either optimistic or pessimistic
• A manager is optimistic if his perceived
  probability of success is higher than the
  objective probability g(q)gtq
• A manager is pessimistic if his perceived
  probability of success is lower than the
  objective probability g(q)ltq

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Modelling the heterogeneity of managers

• Managers are ranked in the continuum
  according to
• their perceived probability of success g?(i)
• their degree of optimism Y?(i) g?(i)/q.

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The framework

• Each manager chooses between a risky project (R,
  ?) and a certain project (C)
• Project C provides the income
• Project R provides the income with
  probability q or else 0.
• Managers are characterized by their perceived
  probability
• Risk is idiosyncratic to each managers project
• There is neither insurance market nor perfect
  diversification markets are incomplete
• Commodity C is the numéraire.

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Lack of Diversification

• Managers do not diversify their activity they
  spend all their time in the implementation of
  their project
• (documented by Moskovitz and Vissing-Jorgensen
  (2002))
• This binary behavior ? Yaaris preference
  function
• there is plunging behavior (Yaari (1987))

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Decision Rule with the Dual Theory of Yaari

• Manager i chooses the risky commodity (R) if
• The relative income depends on
• Relative productivities
• The relative price of the risky commodity (p)
• Each agent can anticipate the general
  equilibrium price if the distribution function of
  perceived probability is common knowledge.

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Autarky equilibrium diagrammatic exposition
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Autarky equilibrium is a second best

• In autarky, general equilibrium exhibits a
  sub-optimal supply of the risky commodity (ex
  post)
• A globally pessimistic country suffers from an
  entrepreneurship deficit
• A globally optimistic country suffers from an
  entrepreneurship excess

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Comparative advantages

• Assume country O is more optimistic than country
  P

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Free trade equilibrium

• Free trade equilibrium price exists and is
  unique
• When demand conditions are identical, country O
  exports commodity R while country P exports
  commodity C.

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Welfare Analysis the need for two criteria

• Ex post criterion effective consumption
• Ex ante criterion specific to each manager i
• with
• Problem of aggregation Hicksian compensated
  incomes are required.

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Simulations

• There is no analytical solutions for the
  resolution of equilibria.
• Numerical simulations are needed for
• equilibria prices, the number of
  entrepreneurs, welfare analysis.
• Ex ante welfare consequences of free trade are
  simulated by the aggregation of heterogeneous
  managers ex ante welfares.

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Ex post welfare analysis

• Country P (country O) is better off with trade
  when the world is globally optimistic
  (pessimistic).
• Simulation results

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Ex ante welfare analysis

• Country O and the world are always better off for
  all the specifications tested while country P can
  be worse off
• Simulation results

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Heterogeneity matters

• When managers have the same distortion of
  probability within a country, both countries are
  ex ante better off with trade (without
  heterogeneity there are no ex ante risk premia in
  autarky).
• (Blanchard and Peltrault 2004).
• Ex ante losses in trade are revealed by the
  introduction of the heterogeneity of managers
  there are positive ex ante risk premia for
  entrepreneurs (except the indifferent one n)
  which flows out to country O with the opening of
  trade.

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Economic Interpretation an example when the
world is optimistic.

• In this case, the Ex post Risk Premium is
  negative
• Negative risk premia flow in country O where the
  level of entrepreneurship is increasing
• The Ex ante Risk Premium is subjective and always
  positive
• Positive ex ante risk premiums flow in country O
  which is then better off

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The psychological distance (Zp) between countries
and the gains from trade
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Economic interpretation the world

• World can be worse off ex-post free trade may
  increase the entrepreneurship excess at the world
  level.
• International trade can amplify the autarky
  distortions as price is a signal of
  psychologically biased productivities.

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Conclusion

• Trade can be grounded on psychology of managers
• Psychological distortions can be amplified by
  trade
• Heterogeneity of managers reveals salient welfare
  effects
• Trade policy decisions are taken that can be
  later regretted
• The best policy is to correct distortions with
  institutional or financial factors bankruptcy
  laws, access to credit