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E&D International Economics, 2 Lecture 11 Giorgia Giovannetti E-mail: [email protected] 13-set 14-set 20-set 21-set 27-set 28-set 04-ott 06-ott 11-ott 13-ott 18-ott 20-ott 25-ott 27-ott 03-nov Introduction:globalization and separation No class Measuring globalization, 1 Measuring Globalization, 2, Indicators Overview trade models (Bernard et al 2007; 2011) Exercises on indicators, data etc China (invited Lecture) The concept of Comparative advantage: the model of Ricardo Ricardo and comparative advantage, 2 Ricardo, end Trade models: H-O H-O, 2 NO CLASS TO BE RECUPERATED Exercises on Ricardo, H-O Welcome piazza san marco 08-nov Trade and imperfect competition Geography models/gravity 10-nov Introduction to the Melitz model 15-nov The Melitz model, wrapping up; Hysteresis, Heterogeneous firms 17-nov Exercises on imperfect competition & Melitz model, recap 22-nov Trade policy 24-nov Trade Policy: TTIP 29-nov FDI and Multinationals: OLI theory 2 people, 2 papers (30 minutes) Crespi, Fleming FDI; 01-dic FDI and Multinationals Offshoring/trade in tasks 3 people, 2 – 3 papers (40 minutes): Bartoli, Rihko, Ronco: GVC 06-dic Brexit discussion 3 people, 2-3 papers (45 minutes) Giannitrapani, Merlika, Avdolli: Brexit then open discussion NO CLASS- TO BE RECUPERATE 2 person, 1 paper (15-20 minutes): Senkebayeva: EU export superstar; 1 paper (15- 20 minutes) Romualdi: EU competitiveness 4 people, 2 articles,( 1,15 hour) Franchino, Perra, Vivoli, Vannelli: Melitz 3 people, 2 -3 papers, (45 minutes) Ding, Khachaturian, Zhao: Offshoring 2 people, 2 papers (30 minutes) Conte, Roshkian: migration, factor mobility, 1 person, 1 paper (20 minutes) Acosta: TTIP; 2 people, 2 papers Persiani, Junde: (30 minutes): China India 4 people, 3 articles, (40 minutes) Bonden, Quaghebeure, denOulenReynaert: trade and wages Summary last lecture • We introduced the H-O model • H-O theory emerged in Sweden. • Eli Heckscher (an economic historian) developed the core idea in a brief article in 1919. • A clear overall explanation was developed and publicized in the 1930s by Heckscher’s student Bertil Ohlin (a professor and politician, a Nobel laureate). • Ohlin’s arguments were later reinforced by Paul Samuelson (another Nobel laureate), who derived mathematical conditions under which the H-O prediction was strictly correct. 3 H-O The H-O theory emphasizes the role of relative differences in resource endowments as the ultimate determinant of comparative advantage. The H-O theory explains comparative advantage in terms of underlying 1. differences across countries in the availability of factor resources (factor endowment) – abundant vs scarce factors; 2. differences across products in the use of these factors in producing the products – laborintensive, capital-intensive, land-intensive, etc. 4 Factor abundance • different factor endowments refers to different relative factor endowments, not different absolute endowments. • In other words, different factor endowments = different factor proportions. 5 Relative factor abundance May be defined in two ways: • physical definition (in terms of the physical units of two factors). For example, (K/L)I > (K/L)II Country I is capital-abundant; • price definition (in terms of the relative prices. The greater the relative abundance of a factor, the lower its relative price). For example, (r/w)I < (r/w)II Country I is capital-abundant. 6 Commodity factor intensity • A commodity is said to be factor-X-intensive whenever the ratio of factor X to a second factor Y is larger when compared with a similar ratio of factor usage of a second commodity. Consider labor: • A country is relatively labor-abundant if it has a higher ratio of labor to other factors than does the rest of the world. • A product is relatively labor-intensive if labor costs are a greater share of its value than they are of the value of other products. 7 How does the relative abundance of a resource determine comparative advantage? • When a resource is relatively abundant, its relative cost is less than in countries where it is relatively scarce. • Difference in relative resource costs causes the pre-trade differences in relative product prices between two countries. 8 H-O in their words… • The H-O theory says, in Ohlin’s own words: Commodities requiring for their production much of [abundant factors of production] and little of [scarce factors] are exported in exchange for goods that call for factors in the opposite proportions. Thus indirectly, factors in abundant supply are exported and factors in scanty supply are imported. (Ohlin, Bertil. International and Interregional Trade, MA: Harvard University Press, 1933) 9 H-O Summary • The Heckscher-Ohlin (H-O) Model Assumptions – Homogeneous goods and factors – Perfectly competitive market equilibrium throughout (goods and factors) – Production functions • Constant returns to scale • Non-joint – Factors • Perfectly mobile across industries • Perfectly immobile across countries – Countries differ in factor endowments – Industries differ in factor intensities 10 H-O Model – Two goods (different intensities), two factors; – Both factors can move freely between the industries. – Shoe production is labor-intensive—it requires more labor per unit of capital to produce shoes than computers. – Foreign is labor abundant; the labor-capital ratio in Foreign exceeds that in Home. Equivalently, Home is capital abundant. – The final outputs can be traded freely between nations, but labor and capital do not move between countries. – The technologies used to produce the two goods are identical across the countries. – Consumer tastes are the same across countries, and preferences for computers and shoes do not vary with a country’s level of income. First we determined equilibrium in autharky The Textbook 2×2 H-O Model, summary • • • • • Goods X, Y Factors K, L X is K-intensive Goods are final goods Trade is – Free and frictionless, or – Subject to simple, constant trade costs per unit (perhaps “iceberg”) 13 Summary Heckscher-Ohlin Model No-Trade Equilibrium Production Possibilities Frontiers, Indifference Curves, and No-Trade Equilibrium Price FIGURE 4-2 (1 of 3) No-Trade Equilibria in Home and Foreign The Home production possibilities frontier (PPF) is shown in panel (a), and the Foreign PPF is shown in panel (b). Because Home is capital abundant and computers are capital intensive, the Home PPF is skewed toward computers. Summary Heckscher-Ohlin Model No-Trade Equilibrium Production Possibilities Frontiers, Indifference Curves, and No-Trade Equilibrium Price FIGURE 4-2 (2 of 3) No-Trade Equilibria in Home and Foreign (continued) Home preferences are summarized by the indifference curve, U. The Home no-trade (or autarky) equilibrium is at point A. The flat slope indicates a low relative price of computers, (PC /PS)A. Summary Heckscher-Ohlin Model No-Trade Equilibrium Production Possibilities Frontiers, Indifference Curves, and No-Trade Equilibrium Price FIGURE 4-2 (3 of 3) No-Trade Equilibria in Home and Foreign (continued) Foreign preferences are summarized by the Foreign is labor-abundant and shoes are labor- intensive, so the Foreign PPF is skewed indifference curve, U* The Foreign no-trade equilibrium is at point toward shoes. A*, with a higher relative price of computers, as indicated by the steeper slope of (P*C /P*S)A*. Then we opened up to trade …. Summary: Heckscher-Ohlin Model Free-Trade Equilibrium Home Equilibrium with Free Trade FIGURE 4-3 (1 of 2) International Free-Trade Equilibrium at Home At the free-trade world relative price of computers, (PC /PS)W, Home produces at point B in panel (a) and consumes at point C, exporting computers and importing shoes. Point A is the no-trade equilibrium. The “trade triangle” has a base equal to the Home exports of computers (the difference between the amount produced and the amount consumed with trade, (QC2 − QC3). Summary: Heckscher-Ohlin Model Free-Trade Equilibrium Home Equilibrium with Free Trade FIGURE 4-3 (2 of 2) International Free-Trade Equilibrium at Home (continued) The height of this triangle is the Home imports of shoes (the difference between the amount consumed of shoes and the amount produced with trade, QS3 − QS2). In panel (b), we show Home exports of computers equal to zero at the notrade relative price, (PC /PS)A, and equal to (QC2 − QC3) at the freetrade relative price, (PC/PS)W. Summary Heckscher-Ohlin Model Free-Trade Equilibrium Foreign Equilibrium with Free Trade FIGURE 4-4 (1 of 2) International Free-Trade Equilibrium in Foreign At the free-trade world relative price of computers, (PC /PS)W, Foreign produces at point B* in panel (a) and consumes at point C*, importing computers and exporting shoes. Point A* is the no-trade equilibrium.) The “trade triangle” has a base equal to Foreign imports of computers (the difference between the consumption of computers and the amount produced with trade, (Q*C3 − Q*C2). Summary Heckscher-Ohlin Model Free-Trade Equilibrium Foreign Equilibrium with Free Trade FIGURE 4-4 (2 of 2) International Free-Trade Equilibrium in Foreign (continued) The height of this triangle is Foreign exports of shoes (the difference between the production of shoes and the amount consumed with trade, Q*S2 – Q*S3). In panel (b), we show Foreign imports of computers equal to zero at the no-trade relative price, (P*C /P*S)A*, and equal to (Q*C3 − Q*C2) at the free-trade relative price, (PC /PS)W. Summary: Heckscher-Ohlin Model Free-Trade Equilibrium Equilibrium Price with Free Trade Because exports equal imports, there is no reason for the relative price to change and so this is a free-trade equilibrium. FIGURE 4-5 Determination of the Free-Trade World Equilibrium Price The world relative price of computers in the free-trade equilibrium is determined at the intersection of the Home export supply and Foreign import demand, at point D. At this relative price, the quantity of computers that Home wants to export, (QC2 − QC3), just equals the quantity of computers that Foreign wants to import, (Q*C3 − Q*C2). Summary: Heckscher-Ohlin Model Free-Trade Equilibrium Pattern of Trade • Home exports computers, the good that uses intensively the factor of production (capital) found in abundance at Home. • Foreign exports shoes, the good that uses intensively the factor of production (labor) found in abundance there. • This important result is called the Heckscher-Ohlin theorem. More in detail: Heckscher-Ohlin • Since the two nations have equal tastes, they face the same indifference map. Indifference curve I is the highest IC that Nation 1 and Nation 2 can reach in isolation, and points A and A/ represent their equil. points of production and consumption in the absence of trade. The tangency of IC I at points A and A/ defines the no-trade equil-relative commodity prices of PA in Nation 1 and PA/ in Nation 2. Since PA < PA/ , Nation 1 has a com-adv. in X and Nation 2 has a com-adv. in Y. The Heckscher-Ohlin Model. The right panel shows that with trade Nation 1 specializes in X and Nation 2 in Y. Specialization continues until Nation 1 reaches point B and Nation 2 B/, where the transformation curves are tangent to the common relative price line PB. Nation 1 exports X in exchange for Y and consume at point E on IC II. Nation 2 exports Y for X and consume at point E/ (which coincides with point E). Note that Nation 1’s exports of X equal Nation 2’s imports of X (i.e. BC=C / E /). Similarly, Nation 2’s exports of Y equal Nation 1’s imports of Y (i.e. B / C / =C E). At PX/PY > PB, Nation 1 want to export more of X than Nation 2 wants to import at this high relative price, and PX/PY falls towards PB. At PX/PY < PB, Nation 1 want to export less of X than Nation 2 wants to import at this low relative price, and PX/PY rises towards PB. Point E involves more of Y but less of X than point A However, Nation 1 gains from trade because E is on higher IC II. Similarly, at E/ which involves more X but less Y than A/, Nation 2 is better of because E/ is on higher IC II. Heckscher-Ohlin Model • When a country opens to trade: – The relative price of computers in Home rises from the notrade price. • This gives Home an incentive to produce more computers and export the difference. – The relative price of computers in Foreign falls from the notrade price. • This gives Foreign an incentive to produce fewer computers and import the difference. • This also means the relative price of shoes in Foreign arises giving Foreign the incentive to increase production and export the difference H-O Summary • The Heckscher-Ohlin (H-O) Model Implications – Countries export goods that use intensively their abundant factors (H-O Theorem) – Trade draws factor prices closer together across countries, becoming equal in certain circumstances (FPE Theorem) – Trade changes real factor prices (S-S Theorem) • Benefiting owners of abundant factors • Hurting owners of scarce factors – Rybczynski Thm (output effects of factor accumulation) 29 Strong … Assumptions • • • • Perfect competition Constant returns to scale No factor mobility Two countries must be identical and trade must be balanced Test of the Heckscher-Ohlin Model The Test: • W. Leontief (1951) • Could “H-O … Factor Proportions Theory” be used to explain the types of goods the United States imported and exported? The Method: Built input-output model for 200 U.S. industries for 1947 EMPIRICAL EVIDENCE ON THE H-O FACTOR-PROPORTIONS THEORY The Findings: • The Leontief Paradox – Leontief found that U.S. exports were less capital-intensive than U.S. imports, even though U.S. is the most capital-abundant country in the world The Leontief Paradox The Controversy: Findings were the opposite of what was generally believed to be true! Reconciliations of the Leontief Paradox • U.S. workers are more productive than foreign workers (Leontief) and Human Skills Theory (1966) • A third factor, natural resources, is not considered (Vanek) • U.S. tariffs on labor-intensive goods are high (Travis) • The identical tastes assumption is violated; Table (next page) shows that consumption patterns differ across countries Consumption Shares by Product Type for OECD Countries Average Values 1985–1999* Human Skills Theory • Donald Keesing (1966) • Emphasizes differences in endowments and intensities of skilled and unskilled workers. • Explains the Leontief paradox: Since the U.S. has highly trained, educated workers relative to other countries, U.S. exports tend to be skilled-labor intensive. Testing the H-O Theorem: Leontief’s Paradox – Wassily Leontief performed the first test of the HO theorem in 1953 using data for the U.S. from 1947. – He measured the amounts of labor and capital used in all industries needed to produce $1 million of U.S. imports and to produce $1 million of imports into the U.S. – This data also shows the capital/labor ratio in dollars per person. Heckscher-Ohlin Model Leontief’s Test H-O Model • Leontief used labor and capital used directly in the production of final good exports in each industry. • He also measured the labor and capital used indirectly in the industries that produced the intermediate inputs used in making exports. • The capital is high because we are measuring the whole capital stock—not the part actually used to produce exports. • The capital/labor ratio was $14,000: each person employed was working with $14,000 worth of capital. • It was impossible for Leontief to get information on the amount of labor and capital used to produce imports. • He used data on U.S. technology to estimate amounts of labor and capital used in imports from abroad. (Remember the HO model assume technologies are the same across countries.) • This gave a capital/labor ratio of $18,200 per worker. – This exceeds the ratio for exports. H-O Model • Leontief assumed correctly that in 1947 the U.S. was capital abundant relative to the rest of the world. – From the HO model, Leontief expected that the U.S. would export capital intensive goods and import labor intensive goods. • Leontief, however, found the opposite. – The capital labor ratio for U.S. imports was higher than for exports. • This contradiction came to be called Leontief’s paradox. The Leontief Paradox • Why would this paradox exist? • U.S. and foreign technologies are not the same as assumed. • By focusing only on labor and capital, land abundance in the U.S. was ignored. • No distinction between skilled and unskilled labor. • The data for 1947 could be unusual due to the recent end of WWII. • The U.S. was not engaged in completely free trade as is assumed by the HO model. Leontief Paradox, 2 • Several of the explanations depend on having more than two factors of production. – The U.S. is land abundant, and much of what it was exporting might have been agricultural products which use land intensively. – It might also be true that many of the exports used skilled labor intensively. • More current research was aimed at redoing the Leontief test. – The “extended” HO model works much better for the same year of data. Summary Testing the Heckscher-Ohlin Model Differing Productivities across Countries Measuring Factor Abundance Once Again To allow factors of production to differ in their productivities across countries, we define the effective factor endowment as the actual amount of a factor found in a country times its productivity: Effective factor endowment = Actual factor endowment • Factor productivity Criticism • We may not see the clear-cut income distribution effects with trade because relative factor prices in the real world do not often appear to be as responsive to trade as the H-O and S-S imply. • In addition, income distribution reflects not only the distribution of income between factors of production but also the ownership of the factors of production. Since individuals or households often own several factors of production, the final impact of trade on personal income distribution is far from clear. 44 Effects of Trade on Factor Prices • How do the changes in pre-trade and posttrade relative prices affect the wage paid to labor in each country and the rental earned by capital? – Remember the relative price of computers in Home increase, causing them to export computers. – The relative price of computers in Foreign decreases, causing them to import computers. Effects of Trade on Factor Prices • Effect of Trade on the Wage and Rental of Home – We can use the relative demand for labor in each industry to derive an economy-wide relative demand for labor. – We can then compare it to the economy-wide relative supply of labor, L/K. – This will determine Home’s relative wage and what happens after the relative price of computers changes. Effects of Trade on Factor Prices • Economy-Wide Relative Demand for Labor – The quantities of labor and capital used in each industry add up to the total available labor and capital. • K = KC + KS and L = LC + LS • We can divide total labor by total capital to get the relative supply equal to the relative demand. L LC LS LC KC K K KC K Relative Supply LS KS Relative Demand KS K Effects of Trade on Factor Prices • The relative demand is a weighted average of the labor-capital ratio to each industry. – This weighted average is obtained by multiplying the laborcapital ratio for each industry by KC/K and KS/K. • These are the shares of total capital employed in each industry. • The equilibrium relative wage is determined by the intersection of the relative supply (L/K) and the relative demand curves. – Remember the amounts of labor and capital do not depend on the relative wage. Effects of Trade on Factor Prices • The relative demand is an average of the labor curves for each industry. • The relative demand curve therefore lies between these two curves. • Where the curves intersect gives the wage relative to the rental: W/R. Effects of Trade on Factor Prices Point A describes an equilibrium in the labor and capital markets—it combines these two markets into a single diagram by showing the relative supply equal to the relative demand. Effects of Trade on Factor Prices • Increases in the Relative Price of Computers – PC/PS increases at Home. – Production shifts away from shoes to computers. • Shoe production decreases and computer production increases. – Labor and capital both move from shoe production to computer production. – Relative labor supply does not change. – Since capital has shifted to the computer industry, the relative demand for labor changes. • The terms used in the weighted average, KC/K and KS/K, change. Effects of Trade on Factor Prices • Increases in the Relative Price of Computers – The relative demand for labor is now more weighted toward computers. – The relative demand for labor is now less weighted toward shoes. Effects of Trade on Factor Prices The real wageinfalls which increase the relative Initial equilibrium before increases the amount ofof price of in computers causes change relative price workers per demand unit of capital the relative curve in to computers both industries computers shift left—toward Effects of Trade on Factor Prices • From this, the labor-capital ratio rises in both shoes and computers. • How does this happen? – More labor per unit of capital is released from shoes than is needed to operate that capital in computers. – As the relative price of computers rises, computer output rises while shoe output falls. – Labor is “freed up” to be used more in both industries. Effects of Trade on Factor Prices • We can use our earlier equation for relative supply and demand to show the response to the increase in the relative price of computers, PC/PS. LC K C L K KC K LS K S KS K Relative Supply No change Relative Demand No change in total Effects of Trade on Factor Prices • The relative supply has not changed, so the relative demand cannot change overall. • Individual components of the relative demand change, but counteract each other to keep total relative demand the same. – More capital used in the computer industry so, KC/K rises while KS/K falls. • Output of computers rises and output of shoes falls. – Labor/capital ratio in both industries increases. – The relative demand continues to equal relative supply. Effects of Trade on Factor Prices • Determination of the Real Wage and Real Rental. – Who gains and who loses from the change in the relative price of computers? – We need to determine the change in the real wage and real rental. • The change in the quantity of shoes and computers that each factor of production can purchase. Effects of Trade on Factor Prices • Change in the Real Rental – Because the labor/capital ratio increases in both industries, the marginal product of capital increases. • There are more people to work with each unit of capital. – The rental rate of capital is determined by its marginal product. • R = PC*MPKC • R = PS*MPKS – Capital can move freely between industries in the long run. • The rental rate will be equalized across industries. Effects of Trade on Factor Prices • Change in the Real Rental – Both marginal products of capital increase. – Rearranging the previous equation we get: • MPKC = R/PC and MPKS = R/PS – R/PC measures the quantity of computers that can be purchased with the rental. – R/PS measures the quantity of shoes that can be bought with the rental. – Since the MPKC and MPKS both increase, R/PS and R/PC must increase as well. Effects of Trade on Factor Prices • Change in the Real Rental – Therefore, capital owners are clearly better off when the relative price of capital increases. – Computers are the capital intensive industry and the relative price of capital has increased. An increase in the relative price of a good will benefit the factor of production used intensively in producing that good. Effects of Trade on Factor Prices • Change in the Real Wage – Again we make use of the fact that the labor/capital ratio increases in both industries. – The law of diminishing returns tells us the marginal product of labor must decrease in both industries. – As before the wage is determined by the marginal product of labor and the price of goods. • W = PC*MPLC and W = PS*MPLS – Rearranging • MPLC = W/PC and MPLS = W/PS Effects of Trade on Factor Prices • Change in the Real Wage – W/PC is the quantity of computers that can be purchased with the wage. – W/PS is the quantity of shoes that can be purchased with the wage. – MPLC and MPLS decrease, so W/PC and W/PS decrease. – Labor is clearly worse off due to the increase in the price of computers. Effects of Trade on Factor Prices • The Stolper-Samuelson Theorem: In the long run when all factors are mobile, an increase in the relative price of a good will increase the real earnings of the factor used intensively in the production of that good and decrease the real earnings of the other factor. • Therefore, in the Heckscher-Ohlin model: The abundant factor gains from trade, and the scarce factor loses from trade. Changes in the Real Wage and Rental: A Numerical Example – Suppose we have the following data: – Computers Sales Revenue = PCQC = 100 Earnings of labor = WLC = 50 Earnings of capital = RKC = 50 – Shoes Sales Revenue = PSQS = 100 Earnings of labor = WLS = 60 Earnings of capital = RKS = 40 Shoes are more labor-intensive than computers – The share of total revenue paid to labor in shoes (60%) is more than the share in computers (50%). • When trade opens, the relative price of computers, PC, increases while the price of shoes, PS, does not change. – Computers: % increase in price = ΔPC/PC = 10% – Shoes: % increase in price = ΔPS/PS = 0% Effects of Trade on Factor Prices • Our goal is to see how the increase in the relative price of computers translates into long run changes in the wage and rental. • Rental on capital is calculated by taking total sales revenue in each industry, subtracting the payments to labor, and dividing by the amount of capital: PC QC W LC R KC PS QS W LS R KS Effects of Trade on Factor Prices • Since the price of computers has risen, ΔPC > 0 and ΔPS = 0. • Using this in the last equations: PC QC W LC R KC 0 QS W LS R KS Effects of Trade on Factor Prices • We can rewrite the last equation in percentage changes: R PC PC QC W W LC R PC R KC W R K C R W W LS R W R KS Effects of Trade on Factor Prices • Plugging in data from before R 100 W 50 10% R 50 W 50 R W 60 R W 40 • Our goal is to find out by how much rental and wage change given changes in the relative price of the final goods Solve for 2 unknowns with 2 equations Effects of Trade on Factor Prices • After solving we get: – (ΔW/W) = -(20%/0.5) = -40% – When the price of computers increases by 10%, the wage falls by 40% – Labor can no longer afford to buy as many computers or shoes. – The real wage, measured in terms of either good, has fallen, so labor is worse off. Effects of Trade on Factor Prices • We can also see: – (ΔR/R) = -(ΔW/W)(60/40) = 60% – Rental on capital increases by 60% when the price of computers rises by 10% – Owners of capital can afford to buy more of both computers and shoes. – The real rental measured in terms of either good has gone up, and capital owners are clearly better off. Effects of Trade on Factor Prices • These equations relating the changes in product prices to change in factor prices are sometimes called the “magnification effect.” – They show how changes in the prices of goods have magnified effects on the earnings of factors. – Even modest fluctuations in the relative prices of goods on world markets can lead to exaggerated changes in the long-run earnings of both factors. • This shows why some are opposed to trade and some support it. H-O model, Effects of Trade on Factor Prices: Summary In the long run we can summarize as follows: – For an increase in PC • ΔW/W < 0 < ΔPC/PC < ΔR/R • Real wage falls, real rental increases – For a decrease in PC • ΔR/R < ΔPC/PC < 0 < ΔW/W • Real rental rate falls, real wage increases – For an increase in PS • ΔR/R < 0 < ΔPC/PC < ΔW/W • Real rental falls, real wage increases FACTOR-PRICE EQUALIZATION AND THE DISTRIBUTION OF INCOME • Moving from autarky to free trade – What happens to the relative size of industries? – What happens to the payments or returns to factors of production? – What happens to the distribution of income within the country? FACTOR-PRICE EQUALIZATION AND THE DISTRIBUTION OF INCOME • Factor-Price Equalization – When trade occurs between countries with different factor proportions, free trade will equalize the relative price of the goods (we saw this in H-O) – … and cause the relative factor prices to converge – Convergence of factor prices happens in the long run FACTOR-PRICE EQUALIZATION AND THE DISTRIBUTION OF INCOME • Factor-Price Equalization – Whichever factor receives the lowest price before two countries begin to trade will therefore tend to become more expensive relative to other factors in the economy, … while those with the highest price will tend to become cheaper. FACTOR-PRICE EQUALIZATION AND THE DISTRIBUTION OF INCOME • For example – U.S. and India – Trade opening up causes prices of machines and the prices of cloth to equalize between countries (H-O) – Size of machine and cloth industries will change for each country changing their industrial structure FACTOR-PRICE EQUALIZATION AND THE DISTRIBUTION OF INCOME • (Assume) U.S. has a comparative advantage in machines … (machines are K intensive) – This causes an increased demand for machines – The price of machines rises relative to price of cloth – Machine production expands – Cloth production contracts – Increased demand for inputs to make machines FACTOR-PRICE EQUALIZATION AND THE DISTRIBUTION OF INCOME … (continued) – Increase in capital greater than increase in labor as machines are capital intensive – Resources shift from cloth to machines – Cloth industry declines • • • • Imports replace much domestic production More labor than capital released on market Shortage of capital increase “profit” (return to K) Surplus of labor decreases wages • Ratio of wages to “profit” (return to K) declines FACTOR-PRICE EQUALIZATION AND THE DISTRIBUTION OF INCOME • India has a comparative advantage in cloth – Increased demand for cloth – Price of cloth rises relative to price of machines – Machine production contracts – Cloth production expands – Increased demand for inputs to make cloth FACTOR-PRICE EQUALIZATION AND THE DISTRIBUTION OF INCOME • Increase in labor greater than increase in capital as cloth is labor intensive • Resources shift from machines to cloth • Machine industry declines – – – – Imports replace much domestic production More capital than labor released on market Shortage of labor increase wages Surplus of capital decreases “profit” • Ratio of wages to “profit” increases FACTOR-PRICE EQUALIZATION AND THE DISTRIBUTION OF INCOME • Wages – Decline in U.S. – Increase in India • “Profits” (return to capital) – Increase in U.S. – Decrease in India Overall – Factor Prices get closer to equalization (just as we saw with “Goods Prices” in H-O FACTOR-PRICE EQUALIZATION AND THE DISTRIBUTION OF INCOME • Trade and the Distribution of Income – Trade produces a convergence of relative prices – Changes in relative prices have strong effects on the relative earnings of labor and capital in both countries • In U.S., where the relative price of machines rises • Capitalists are made better off and workers are made worse off • In India, where the relative price of machines falls, the opposite happens • Capitalists are made worse off and workers are made better off – Owners of a country’s abundant factors gain from trade, but owners of a country’s scarce factors lose FACTOR-PRICE EQUALIZATION AND THE DISTRIBUTION OF INCOME Table 4.4 Economic Data for South Korea and India Economic Variable GDP per Capita Capital/Worker Degree of Openness [(Exports + Imports)/GDP] South Korea India Year Value Year Value 1953 $796 1953 $641 1962 $928 1962 $760 1972 $1,450 1972 $786 1982 $3,395 1982 $936 1991 $7,251 1991 $1,251 1965 $2,093 1965 $786 1975 $6,533 1975 $1,259 1085 $12,036 1085 $1,712 1992 $17,995 1992 $1,997 1953 11.8% 1953 10.4% 1962 22.1% 1962 11.2% 1972 44.5% 1972 8.8% 1982 71.5% 1982 14.5% 1990 62.5% 1990 21.2% More on the Stolper-Samuelson Theorem • Derived from the HO model • Assumptions: – Labor earns wages proportionate to its skill level – Owners of capital earn profits – Landowners earn rents – The amount of income earned per unit of input depends on both the demand for inputs and the supply of inputs (demand for an input = derived demand) The Stolper-Samuelson Theorem • An increase in the demand for a good (opening International Trade?) … increases the price of a good…. and raises the income earned by factors that are used intensively in its production • Conversely, decrease in the demand for a good … decreases the price of a good…. and reduces the income earned by factors that are used intensively in its production The Stolper-Samuelson Theorem Example … increase production of steel … increase need for K ... The Stolper-Samuelson Theorem • Note: • Not all factors used in the export industries will be better off, and not all factors used in import competing industries get hurt: Abundant factors will benefit, while scarce ones will be hurt The Stolper-Samuelson Theorem • Ultimately, the effects on income of an opening of trade depends on the flexibility of the affected factors – If labor is stuck in bread production and unable to move to making steel, it will be hurt much worse than when it is flexible and free to move – U.S. avocado producers might not oppose Mexican avocado imports as fiercely as they do, if they could easily move to producing other goods Implications of Stolper-Samuelson Theorem • Some groups in society will oppose international trade. • Scarce factors will lobby government for trade protection. • Even though some in society lose, the country overall benefits from international trade relative to autarky. • A system of taxation and transfers could be developed to compensate the losers while leaving the gainers better off relative to autarky. Implications of Stolper-Samuelson Theorem • Some groups in society will oppose international trade. • Scarce factors will lobby government for trade protection. • Even though some in society lose, the country overall benefits from international trade relative to autarky. • A system of taxation and transfers could be developed to compensate the losers while leaving the gainers better off relative to autarky. 4-91 Extending the Heckscher-Ohlin Model • The HO model can be made more realistic by allowing for more than two goods, factors, and countries. – This is the first modification to the model. • As the second modification, we will allow the technologies used to produce each good to differ across countries. Extending the H-O Model • Many Goods, Factors, and Countries – The predictions of the HO model depend on knowing what factor a country has in abundance, and which good uses that factor intensively. – When there are more than two goods, it is more complicated to evaluate factor intensity and factor abundance. • Measuring the Factor Content of Trade – How do we measure the factor intensity of exports and imports when there are thousands of products traded between countries? – How can we use this to test the HO model? Extending the H-O Model • Measuring the Factor Content of Trade – Using Leontief’s test, we can look at similar data. – We can multiply his numbers shown in Table 4.2 by the actual value of U.S. exports and U.S. imports. • This gives values for “total exports” and “total imports.” – These values are called the factor content of exports and factor content of imports. • They measure the amounts of labor and capital used to produce exports and imports. – By taking the difference between the factor content of exports and factor content of imports. Extending the Heckscher-Ohlin Model Factor Content of Trade for the United States, 1947 Seen yesterday This table extends Leontief’s test of the Heckscher-Ohlin model to measure the factor content of net exports. The first column for exports and for imports shows the amount of capital or labor needed per $1 million worth of exports from or imports into the United States, for 1947. The second column for each shows the amount of capital or labor needed for the total exports from or imports into the United States. The final column is the difference between the totals for exports and imports. Extending the Heckscher-Ohlin Model • Measuring the Factor Content of Trade – Since both these factor contents are positive, we see that the U.S. was running a trade surplus. – The U.S. exported large amounts of goods to help countries of Europe rebuild after WWII. – The fact that the factor content of net exports for both capital and labor are positive will be important as we move forward. Extending the H-O Model • Measuring Factor Abundance – How should we measure factor abundance when there are more than two factors and two countries? – To determine whether a country is abundant in a certain factor, we compare the country’s share of that factor with its share of world GDP. – If the share of a factor > share of world GDP. • The country is abundant in that factor. – If the share of factor < share of world GDP. • The country is scarce in that factor. Extending the H-O Model Country Factor Endowments, 2000 Extending the H-O Model • Capital Abundance – 24% of the world’s physical capital is located in the U.S., 8.7% is located in China, 13.3% in Japan, etc. – The final bar in the graph shows each country’s % of world GDP. • The U.S. had 21.6% of world GDP, China had 11.2%, Japan had 7.5%, etc. • We can conclude that the U.S. was abundant in physical capital in 2000. – Japan and Germany were also abundant in physical capital. – The opposite holds for China and India—their shares of world capital are less than their share of GDP. • They are scarce in capital. Extending the H-O Model • Labor and Land Abundance – We can use a similar comparison to determine whether each country is abundant or not in R&D scientists, in types of labor distinguished by skill, in arable land, or any other factor of production. – For example: • U.S. is abundant in R&D scientists: 26.1% of the world’s total as compared to 21.6% of the world’s GDP. • The U.S. is also abundant in skilled labor but is scarce in less-skilled labor and illiterate labor. • India is scarce in R&D scientists: 2.5% of world’s total as compared to 5.5% of the world’s GDP. Extending the H-O Model • Labor and Land Abundance – The U.S. is also scarce in arable land which is surprising since we think of the U.S. as a major exporter of agriculture. – Another surprise is that China is abundant in R&D scientists. – These findings seem to contradict HO model. – It is likely that the productivity of R&D scientists and arable land are not the same in both countries. – In this case, shares of GDP are not the whole story. – We need to allow for differences in productivity. Extending the H-O Model • Differing Productivities Across Countries – Remember that Leontief found that the U.S. was exporting labor-intensive products even though it was capitalabundant at that time. – One explanation is that labor is highly productive in the U.S. and less productive in the rest of the world. • Then the effective labor force in the U.S. is much larger than if we just count people. • Effective labor force is the labor force times its productivity. – We can now look at differing productivities into the HO model. Extending the H-O Model • Measuring Factor Abundance Once Again – Effective Factor Endowment is the actual factor endowment times the factor productivity. – The amount of effective labor in the world is found by adding up the effective factor endowments across all countries. – To determine if a country is abundant in a certain factor, we compare the country’s share of that effective factor with share of world GDP. • If share of an effective factor is less than its share of world GDP then that country is abundant in that effective factor. • If share of an effective factor is less than its share of world GDP, then that country is scarce in that effective factor. Extending the H-O Model • Effective R&D Scientists – The effectiveness of an R&D Scientist depends on what they have to work with. – On way to measure this is through a country’s R&D spending per scientist. – If more spending, then scientist will be more productive. – Take the total number of scientists and multiply that by the R&D spending per scientists – Figure 4.10 shows these shares. – With these productivity corrections, the U.S. is more abundant in effective R&D scientists and China is lower. Extending the H-O Model • Effective Arable Land – We also need to do a correction for arable land. – Effective arable land is the actual amount of arable land times the productivity in agriculture. – The U.S. has a very high productivity in agriculture where China has a lower productivity. – We repeat the same calculations from figure of 2000 • The 4th bar graph shows each country’s share of effective arable land, corrected for productivity differences – The numbers before and after the correction are very close. • The U.S. is neither abundant nor scarce in effective arable land. Extending the Heckscher-Ohlin Model “Effective” Factor Endowments, 2000 Food Imports Close to Matching Level of Exports • It is expected that by about 2010, U.S. imports of agricultural goods will be about equal to exports. • That is what the HO model would predict, given our finding that the U.S. is neither abundant nor scarce in effective land. Extending the H-O Theorem • We have now abandoned many of the assumptions we previously made. – We allow for many goods, factors, and countries. – We also allow for factors to differ in productivity. – If a country is abundant in an effective factor, then the factor’s content in net exports should be positive. – If a country is scarce in an effective factor, then that factor’s content in net exports should be negative. Extending the H-O Theorem • The est is as follows – Sign of (country’s % share of effective factor minus the % share of world GDP) equals Sign of (Country’s factor content of net exports). – For example, Table 4.2 shows that for capital the U.S. had a positive factor content of net exports. – Using 35 countries, the U.S. share of GDP of those countries was 33%. – Given the timing after WWII, we can assume that the U.S. share of world capital was more than 33%. – Therefore, the U.S. was abundant in capital and since that factor’s content of net exports was positive, it passes the sign test. Extending the H-O Theorem • The Test – The U.S. share of population for the 35 countries was about 8%. – This is less than the U.S. share of GDP, 33%. – Therefore, the U.S. was scarce in labor. – But labor’s factor content of net exports was positive. – The sign of U.S. factor abundance in labor is thus the opposite of the sign of its factor content of net exports. • The sign test seems to fail for the U.S. in 1947 in labor. – However, the U.S. share of the population is not the right way to measure the U.S. labor endowment. One way to measure productivity is to use wages paid to workers. Extending the H-O Model A plot of wages of workers in various countries and the estimated productivity of workers in 1990 is shown in figure. You can see these are highly correlated. The effective amount of labor found in each country equals the actual amount of labor times the wage. The amount of labor in each country times the average wages gives total wages paid to labor. Extending the H-O Theorem • Doing this for 30 countries and comparing it to the U.S. we find that the U.S. was abundant in effective labor. • Given that the U.S. was abundant in effective factor, then labor also passes the sign test, in addition to capital. • There is no “paradox” in the U.S. pattern of trade. • This explanation for Leontief’s paradox relies on taking into account the productivity differences in labor across countries. – As Leontief himself proposed, once we take into account differences in the productivity of factors across countries, there is no “paradox” after all. Conclusions • The HO model predicts real gains for the factor used intensively in the export good, whose relative price goes up with the opening of trade, and real losses for the other factor. • We have investigated some empirical tests of the HO theorem. • These tests originated with Leontief’s paradox, the finding that U.S. exports just after WW II were relatively labor intensive. Conclusions • With the test reformulated to use factor amounts embodied in net exports and the effective factor endowments in each country, it was found that the U.S. was abundant in effective labor and presumed it was in capital. • The U.S. had positive factor content of L and K in net exports, consistent with the sign test of the extended HO model. H-O, Summary • The HO framework isolates the effect of different factor endowments across countries and determines the impact of these differences on trade patterns, relative prices, and factor returns. • By focusing on the factor intensities among goods, the HO model provides guidance on who gains and who loses from trade: the factor used intensively in the export good, whose relative price goes up with the opening of trade, gains, the other factor looses. Empirics, Summary • The original tests of H-O are due to Leontief, and produced the Leontief’s paradox: the finding that U.S. exports just after WW II were relatively labor intensive. • With the test reformulated to use factor amounts embodied in net exports and the effective factor endowments in each country, it was found that the U.S. was abundant in effective labor and presumed it was in capital. • The U.S. had positive factor content of L and K in net exports, consistent with the sign test of the extended HO model. Free Trade Affects Income Distribution 4-117 Summary, Factor Price Equalization Empirical evidence: no wage equalization Limits Summary: International Trade and income inequalities Trade openess and inequality Wages versus unemployment inequalities Explaining changes in income inequalities Compensating the losers Changes in factor endowments: Rybczynski Theorem • At constant world prices, if a country experiences an increase in the supply of one factor, it will produce more of the product intensive in that factor and less of the other. The Rybcynski Theorem