Download china`s agricultural trade - University of Hawaii at Manoa

A Review of Neo-Classical Trade
Theory & BoP
Lectures 7 & 8 AHEED Course “International
Agricultural Trade and Policy”
Taught by Alex F. McCalla, Professor Emeritus, UC
Davis.
March 31, 2010, University of Tirana, Albania
1
Overview of Trade Theory
• Classical Economists were mostly interested in trade
problems
Why liberalized trade is beneficial
• Adam Smith (1723-1790) studied exploitation of increasing
returns to scale
• David Ricardo studied specialization according to comparative
advantage
• Heckscher and Ohlin argued trade occurs because of
different factor endowments
• Trade improves the efficiency of resource use by shifting
resources to most efficient use
• Every country has a comparative advantage in producing
something; not a zero sum game
• We will study 3 models: Ricardian, Heckscher-OhlinSamuelson (HOS) and if time Jones fixed-factor.
2
Fundamental Basis for Food Trade
• Productive resources are unevenly distributed across the
world
• e.g., BZ has 60 m. ha. of cropped land & another 100-170
m. ha. available for expansion; BZ is 2nd largest soy
exporter & 3rd largest corn exporter.
• Much of BZ land was considered useless until tech change
in 1970s.
• USA: 170 m. ha. cropped & 300 m. people
• China: 140 m. ha. & 1,333 m.
• India: 158 m. ha. & 1,170 m.
• Japan: 5 m. ha. & 127 m.
• Australia 45 m. ha & 21 m.
3
Ricardian Model
Adam Smith : absolute advantage
David Ricardo: corn laws; comparative advantage
Paul Samuelson “Ricardian theory of c.a. is most important
proposition in economics ; is true & non-trivial”
Ricardian Assumptions
1. 1 factor of production - labor
2. 2 countries × 2 goods
3. Constant Factor/Output ratios
4. Factors immobile internationally
5. Pure competition
David Ricardo
(1772-1823)
4
Best Illustrated with an example
Unit Labor requirements
ac
Cloth
Wheat
Home (A)
90 hours per
unit output
80 hours per
unit output
Foreign (B)
100 hours per
unit output
120 hours per unit
output
Labor per
unit output
aw =Lw/Qw
a*c
Resource constraint Lc + Lw = L ; Lc* + Lw* = L*
L, ac, & aw are exogenous; Lc, Lw, Qc & Qw are endogenous
5
Best Illustrated with an example
Unit Labor requirements
ac
Cloth
Wheat
Home (A)
90 hours per
unit output
80 hours per
unit output
Foreign (B)
100 hours per
unit output
120 hours per unit
output
Labor per
unit output
aw =Lw/Qw
a*c
Labor productivity aw = Lw/Qw, so productivity = 1/aw = output per unit labor
Country has Absolute Advantage if it can produce @ lower cost (i.e., higher productivity)
Country A has abs. adv. in cloth if ac < a*c , or if 1/ac > 1/a*c
6
Opportunity cost
• Opp. Cost is defined as value of next best opportunity, so if country
A decides to produce more wheat, opp. cost is loss of cloth production
Lc
• Labor constraint L = awQw + acQc
• Solve for Qc = L/ac – aw/ac(Qw)
Qc
PPF
R
1

x
-aw/ac

Slope gives cost of wheat production
in terms of cloth
S
QW
Slope of PPF = opp. cost
x represents amount of C that must be
given up to produce 1 more unit of wheat;
so x is opp. cost of producing wheat
7
Opp. Cost
Opportunity Cost
(In units of the other good)
Cloth
A: Home
B: Foreign
90/80= 1.1
units wheat
100/120= 0.8
units wheat
Unit Labor requirements
Cloth
Wheat
Home (A)
90 hours
per unit
output
80 hours per
unit output
Foreign
(B)
100
hours
per unit
output
120 hours per
unit output
Wheat
80/90 = 0.9
units cloth
120/100 = 1.2
units cloth
Theory of c.a. compares ratios
Opportunity cost is Economic Cost
8
No wheat
prodn
Gains from trade if Pc/Pw > ac/aw
Cost of cloth prodn.
Pc/PW
- 1.1
A produces both
1.0
0.8
No cloth
prodn
Prices
- B produces both
Both countries
specialize
D
Qc/QW
Country A specializes in cloth if Pc/PW > ac/aw, &
specializes in wheat if Pc/PW < ac/aw , & produces
both if Pc/PW = ac/aw
Why trade? Say Country A has 170 L; in autarky it
produces 90 cloth & 80 wheat, or specializes &
produces 2.1 wheat & trades 1.0 wheat for 1.0 cotton
9
Comparing Productivities-1
•Another way to define c.a. is by comparing productivities; A’s c.a. is in the
good in which it has the greatest productivity advantage.
•Wages are based on productivity, so wages are higher in more productive
country
•Trade flows equalize prices between 2 countries
•Differences in tech.  initial differences in relative prices  trade
Zero profit condition πw = PwQw – wLw = 0
so w = PwQw/Lw = Pw(Lw/aw) / Lw =Pw/aw
This means that if Pc/Pw = 1  w =1/80 units wheat in A &
w* = 1/100 units cloth in B
Bottom Line- Most Likely Outcome -Complete Specialization.
Something we do not Observe –Need More Complete Theory
10
Comparing Productivities-2
Cloth is cheaper in A
if:
Wheat is cheaper in
A if:
Cloth is cheaper in B
if:
Wheat is cheaper in
B if:
wac < w*a*c
waw < w*a*w
w*a*c < wac
w*a*w < waw
or w/w*< a*c /ac
or w/w*< a*w /aw
or w*/w < ac /a*c
or w*/w < aw /a*w
but 1/80÷1/100 > 100/90
& 1.25 < 120/80
& 1/100÷1/80 < 90/100
but 0.8 > 80/120
1.25 > 1.1
1.25 < 1.5
0.8 < 0.9
0.8 > 0.7
Conclude that A’s rel.
productivity in wheat
is > rel. wages
Conclude that B’s rel.
productivity in cloth
is > rel. wages
11
Heckscher-Ohlin-Samuelson (HOS) Model
•
•
H-O-S model says basis of trade is differences in countries’ resources.
The H-O-S theory shows that comparative advantage is influenced by:
• Relative factor abundance (refers to countries)
• Relative factor intensity (refers to goods)
•
HOS theory emphasizes :
–
–
–
–
patterns of trade
impacts of factor growth on trade
factor price equalization
income distribution effects from trade
•
HOS theory argues that international differences in factors of production create
productive differences that explain why trade occurs.
– Countries have relative abundance of factors of production.
– Production processes use factors of production with
relative intensity.
•
HOS theorem: Countries tend to export goods whose production is intensive in
abundant factors & import goods that are intensive in its scarce factors of
production (pattern of trade).
12
HOS Assumptions:
• An economy produces two goods, e..g, cloth & food.
• The production of these goods requires two inputs that are in
limited supply; labor (L) & land (T).
• Production of food is land-intensive & cloth is labor-intensive in both
countries (i.e., identical prodn. functions).
• No factor intensity reversal, constant returns to scale, & both
countries are incompletely specialized.
• Perfect competition in all markets.
13
HOS Production Possibilities
aTC = acres of land used to produce one unit cloth & aLC = hours of labor used to produce one unit cloth
aTF = acres of land used to produce one unit food& aLF = hours of labor used to produce one unit food
L = total amount of labor & T = total amount of land
Production possibilities are influenced by both land and labor
(requirements):
aTF×QF + aTC×QC ≤ T
Land required for each
unit of food
production
Total units of
food
production
Land required for
each unit of cloth
production
aLF×QF + aLC×QC ≤ L
Labor required for
each unit of food
production
Total amount of
land resources
Total units of
cloth
production
Total amount of
labor resources
Labor required for
each unit of cloth
production
14
Concept of Factor Intensity
• Suppose that the domestic country has an abundant amount of labor
(L) relative to the amount of land (T).
– The domestic country is abundant in labor & the foreign country
is abundant in land: L/T > L*/ T*
– Likewise, the domestic country is scarce in land & the foreign
country is scarce in labor.
– However, the countries are assumed to have the same technology
& same consumer tastes.
• If we consider the total resources used in each industry & say that
cloth production is labor intensive & food production is land intensive
if LC /TC > LF /TF.
• Because the domestic country is abundant in labor, it will be relatively
efficient at producing cloth because cloth is labor intensive.
15
QF (Food)
Production Possibilities
Labor constraint: aLFQF + aLCQC ≤ L
So QF ≤ L/aLF - (aLC/aLF )QC
L/aLF
Labor constraint slope = -aLC/aLF
T/aTF
Cloth is lab. intensive so labor const. is steeper
than land const.
aLC/aTC > aLF/aTF , or aLC/aLF > aTC/aTF
Land constraint slope = -aTC/aTF
L/aLc
T/aTC
Qc (Cloth)
16
Production Possibilities
QF (Food)
When land constraint is relaxed, prodn.
possibilities expand in direction towards food
production (Rybczynski theorem).
L/aLF
Labor constraint slope = -aLC/aLF
T/aTF
•
The opportunity cost of producing cloth:
B
–is low when the economy produces a low amount of cloth and a high
amount of food
–is high when the economy produces a high amount of cloth and a low
amount of food
•
A
Land constraint slope = -aTC/aTF
L/aLc
T/aTC
Qc (Cloth)
17
How do the outputs of the two goods change when the
economy’s resources change?
– Rybczynski Theorem:
• If a factor of production (T or L) increases, then the supply of
the good that uses this factor intensively increases and the
supply of the other good decreases for any given commodity
prices.
– The reverse is also true.
• The biased effect of increases (decreases) in resources on
production possibilities is the key to understanding how
differences in resources give rise to international trade.
18
Production Possibilities
With more than one factor of production, the PPF (opp. cost in production) is no
longer a straight line. Why?
Output
of
food, QF
QF
• With substitution of inputs, then the PPF becomes
curved.
– For example, many laborers could work on a
small plot of land or a few laborers could work
on a large plot of land to produce the same
amount of output.
– Unit factor requirements are not constant at
every quantity of cloth & food produced.
Slope = -PC/PF
PP
QC
Output of
19
HOS-Consumers
Demand Side –Individual
preferences shown by
indifference curves Uo, U2
and U3.
Consumer maximizes utility
by choosing combinations of
A & B where her budget line
AB is tangent to highest
indifference curve –point E
If all consumers have
identical preferences,
community indifference
curves have same propertiessocietal welfare is max when
price ratio line is tangent to
highest social indifference
curve
20
HOS Production
AB –all possible combinations
of food and cloth given
country’s labor and capital
endowments;
CD relative price of cloth faced
by producers.
P competitive equilibrium
where pc/pf = mrt of food into
cloth.
XF quantity of food produced;
XC quantity of cloth produced
21
HOS Autarky
With no trade consumers
and producers are in
equilibrium when both the
PPC and MRS are tangent
to the price line.
This occurs at point A
Where (CF =XF) = (CC = XC)
i.e. is when both are
tangent to the price line
PA.
Production of each good
equals consumption of
each good.
Now let there be trade
22
HOS –With Trade
2 country world and that in
equilibrium- world equilibrium
price is p*
Given p* the optimum
production in our country is at P
where p* is tangent to the PPF at
point ACountry produces XC of cloth & X F
of food.
Given p* consumer can reach a
higher indifference where p* is
tangent to uF at point C
Country consumes CC of cloth
and CF of food
The country exports Cc-Xc of
cloth and imports CF-XF of food
CBP is trade triangle –gains from
trade. Country is better off i.e. is
on a higher utility curve Uf>UA
23
Trade in the HOS Model
• An economy will be relatively efficient at producing goods
that are intensive in the factors of production in which the
country is relatively well endowed.
• Since cloth is a labor intensive good, the domestic
country’s PPF will allow a higher ratio of cloth to food
relative to the foreign county’s PPF.
• At each relative price, the domestic country will produce a
higher ratio of cloth to food than the foreign country.
– The domestic country will have a higher relative supply
of cloth than the foreign country.
24
HOS- Factor Intensity, Factor
prices &Product Prices
One good produced- one unit can
be produced using varying combos
of K & L : Q – Q is a unit isoquant;
Least cost combo where ratio of
factor prices = slope of QQ.
If initially isocost line (input price
ratio) equals AB, point E is such a
point.
Cost minimizing K/L ratio is slope of
ray OE.
Suppose wage/rental rate rises
which implies steeper isocost line
CD
Cost minimizing point now F and K/L
ratio is slope of ray OF which has
increased.
25
Factor Prices & Goods Prices
An increase in the relative price of food, PF /PC , will:
– raise profits in food sector relative to that of labor, r/w and attracts
new firms to food sector
– Given that food is more capital intensive ,the increased demand for
capital will be greater than that released from cloth sector.
– Result excess demand for capital and excess supply of labor which bids
up return to capital and lowers return to labor.
– raise the real income of capital owners and lower the real income of
labor in both sectors.
– Stolper-Samuelson Theorem:
• If the relative price of a good increases, holding factor
supplies constant, then the nominal and real return (in
terms of both goods) to the factor used intensively in
the production of that good increases, while the
nominal and real return (in terms of both goods) to the
other factor decreases.
– The reverse is also true.
26
What says is that relative product prices uniquely determine
factor prices.
Given that free trade will equate relative commodity prices
across countries, it follows factor prices will be equalized
across countries that have same technology even though
factors are assumed be immobile internationally. Leads to:
Factor Price Equalization Theorem
• International trade leads to complete equalization in
the relative and absolute returns to homogeneous
factors across countries.
• It implies that international trade is a substitute for the
international mobility of factors.
27
Trade in the HOS Model
• An economy will be relatively efficient at producing goods
that are intensive in the factors of production in which the
country is relatively well endowed.
• Since cloth is a labor intensive good, the domestic
country’s PPF will allow a higher ratio of cloth to food
relative to the foreign county’s PPF.
• At each relative price, the domestic country will produce a
higher ratio of cloth to food than the foreign country.
– The domestic country will have a higher relative supply
of cloth than the foreign country.
28
Trade in the HOS Model
• The H-O model predicts a convergence of relative prices with trade.
Because relative prices are equalized & given the direct relationship
between relative prices & factor prices, factor prices are also equalized.
• Trade increases the demand for goods produced by abundant factors,
indirectly increasing the demand for the abundant factors themselves,
raising the factor prices of the abundant factors across countries.
• With trade, the relative price of cloth will rise in the domestic country & fall
in the foreign country.
– In the domestic country, the rise in the relative price of cloth leads to a rise
in the relative production of cloth & a fall in relative consumption of cloth;
the domestic country becomes an exporter of cloth & an importer of food.
– The decline in the relative price of cloth in the foreign country leads it to
become an importer of cloth & an exporter of food.
29
Income Distribution in HOS Model
• Because an economy can afford to consume more with
trade, the country as a whole is made better off.
• But some do not gain from trade, unless the model
accounts for a redistribution of income.
• Trade changes relative prices of goods, which have effects
on the relative earnings of labor & land.
– A rise in the price of cloth raises the purchasing power of domestic
laborers, but lowers the purchasing power of domestic land
owners.
• The model predicts that with trade owners of abundant
factors gain, but owners of scarce
factors lose.
30
Empirical Evidence on the HOS Model
• Because factor prices are not equalized across countries, the predicted volume of
trade is much smaller than actually occurs.
– A result of “missing trade” discovered by Daniel Trefler (‘95).
• The reason for this “missing trade” appears to be the assumption of identical
technology among countries.
– Technology affects the productivity of labor & therefore the value of labor
services.
– A country with high technology & a high value of labor services would not
necessarily import a lot from a country with low technology & a low value of
labor services.
• Tests on North-South Trade: North-South trade in manufactures seems to fit the HO theory much better than the overall pattern of international trade.
31
Summary
• The H-O model, in which two goods are produced using two
factors of production, emphasizes the role of resources in trade.
• A rise in the relative price of the labor-intensive good will shift the
distribution of income in favor of labor:
– The real wage of labor will rise in terms of both goods, while
the real income of landowners will fall in terms of both goods.
• The owners of a country’s abundant factors gain from trade, but
the owners of scarce factors lose.
• In reality, complete factor price equalization is not observed
because of wide differences in resources, barriers to trade, &
international differences in technology.
• Empirical evidence is mixed on the H-O model.
– Most economists do not believe that differences in resources
alone can explain the pattern of world trade or world factor
prices.
32
The Financial Side of Trade
• So far we have been dealing with “real” trade theory
where we have looked at why countries would gain
from trading but not how.
• Unless in barter economy, need a medium of
exchange - money or currency.
• Given that countries have their own money/currency
the needs to be a market where you can exchange
one currency for another.
• Called Foreign Exchange(Fx) Markets
• So will briefly look at why Fx transactions are NB,
• And will say a word about the Balance of Payments
33
Foreign Exchange Trading
• For every international transaction involving real goods there is an equal and
opposite monetary transaction.
• Italy buys wheat from Canada and Canada wants payment in $CAN so Italy
sells Euros to buy $ in the Fx markets.
•
so export of wheat has caused an import of $CAN;
• In Fx market supply of Euros has gone up putting downward pressure on
price of Euros; and the demand for $CAN puts upward pressure P of $CAN.
• The ratio of prices of any two currencies is the exchange rate $/Eur,Yen/Peso, Yuan/Rupee.
• Given differences to timing of real & monetary transaction, there have
developed futures markets for currencies as well as goods which allow
traders to hedge against changes in Ex Rates.
• Critical because if a country devalues its currency it exports are cheaper for
the ROW and the imports it buys abroad are more expensive.
34
A Country’s Balance of Payments
(BoP)- Accounts Always Balance
Credits
Debits
• Current/Merchandise
Account-
• Current Account-
– exports of goods;
– Investment income;
– Sales of services.
Capital Accountborrowing from abroadexporting IOU’s
– Imports of goods;
– Payments to foreign markets
–interest, repatriated
earnings;
– Travel abroad
Capital AccountLending to foreigners
public and private.
35
BoP cont.
• So when hear that US has a huge trade deficit it means its
current account is in deficit -it is importing more goods
and services than it is exporting.
• In principle this should put downward pressure on the
price of $US;
• But if others -e.g. the Chinese- are buying US bonds, this
is an export of IOU’s and is counted as a credit bringing
the BOP into balance.
• Wont go further here- basic point is that you keep in
mind that every international transaction involves 2
markets.
36