EC 340

Lecture 2 - Winners and Losers from International Trade

from last time
immiserizing growth
Rybczynski theorem
winners and losers within a country
Stolper-Samuelson theorem
factor price equalization theorem
trade and income inequality
Leontief paradox
trade and jobs
trade and technology


From Last Time

How is the world price determined? By supply and demand in the international trade market.

determination of world price
The world price equates the demand for imports with the supply of exports.


Immiserizing Growth

Specializing more in producing goods for export can make the whole nation worse off. Why? Exporting more of a good lowers its price on world markets, so revenues from exports may fall.

immiserizing growthSuppose Brazil expands its capacity to grow coffee beans. The supply of coffee will increase and the price will fall. Production moves from A to C and consumption from B to D. Brazil is now on a lower indifference curve.



Rybczynski Theorem

If the terms of trade are fixed, the growth of one factor of production reduces the output of one good.

The growth of one factor relative to others raises the output of the sectors using it intensively and reduces the outputs of the other sectors. The expanding sector out-competes the other sectors for factors of production. This outcome is referred to as Dutch disease where the development of the natural gas industry limited the development of the manufacturing sector.Rybczynski theorem


Winners and Losers within a Country

Trade does hurt large groups within an economy. We can use the Heckscher-Olin theory to examine the effects of trade on factor prices. Suppose that wheat is cheap and cloth is expensive in the U.S. and that trade opens up with the rest of the world.
So, some are absolutely better off and some worse off as a result of free trade.


Stolper-Samuelson Theorem

assumptions:
  1. 2 goods (wheat and cloth)
  2. 2 factors of production (land and labor)
  3. perfect competition
  4. full-employment
  5. wheat is land-intensive and cloth is labor-intensive
  6. factors are mobile between sectors but not countries
  7. trade raises the relative price of wheat
Under assumptions (1)-(7), moving from no trade to free trade unambiguously raises the returns to the factor used intensively in the rising-price industry (land) and lowers the return to the factor used intensively in the falling-price industry (labor), regardless of which goods the sellers of the two factors prefer to consume.

The more a factor is specialized into the production of exports the more it gains from trade; the more a factor is specialized in the production of importable goods, the more it stands to lose from trade.


Factor Price Equalization Theorem

assumptions:
  1. 2 factors of production (land & labor), 2 commodities, and 2 countries
  2. competition
  3. factor supplies are fixed and immobile between countries
  4. full employment
  5. no transportation costs
  6. no tariffs or other barriers to trade
  7. production functions for each industry are the same between countries
  8. no economies of scale
  9. factor-intensities are the same at all factor-price ratios
  10. both countries always produce both goods
Under assumptions (1)-(10), free trade will equalize factor prices so that all laborers will earn the same wage rate and all units of land will earn the same rent in both countries.

Suppose that labor is scarce. The country will import labor-intensive products. The demand for labor in labor-intensive industries falls. So, wages fall in the scarce labor country.

Where labor is cheap, the country will export labor-intensive products. The demand for labor there rises, so wages go up in the cheap labor country.

Trade is a substitute for the migration of labor.


Trade and Income Inequality

Trade has been blamed for the growing gap between the wages of skilled and unskilled workers in the U.S. The rising wage differential should lead employers to decrease the proportion of skilled workers and increase the proportion of unskilled workers. In reality, nearly all industries have employed an increasing proportion of skilled workers.


Leontief Paradox

If the U.S. is capital abundant, it should be exporting capital-intensive goods and importing labor-intensive goods. Leontief found that the U.S. was exporting labor-intensive goods and importing capital-intensive goods. The U.S. is actually abundant in skilled labor and farmland. This is consistent with the U.S. pattern of trade.


Trade and Jobs

U.S. export industries involve more jobs than do U.S. import-competing industries.

Cutting imports will lead to a fall in exports.

  1. exports use importable inputs
  2. foreigners who lose our business cannot buy so much from us
  3. foreign governments may retaliate
Therefore, raising trade barriers will bring a net loss of U.S. jobs.

Lowering existing trade barriers will bring a net job loss because current barriers are concentrated in the most labor-intensive import competing industries such as textiles and footwear.


Trade and Technology

When a product is invented it needs to be perfected and requires advanced technological inputs. Production is best done in the country where the product was invented. Once a product becomes standardized and knowledge plays less of a role and production moves overseas eventually to cheap labor LDC's.



David A. Latzko
318 COB
Department of Business and Economics
Wilkes University
Wilkes-Barre, PA 18766
phone: (717) 408-4718
fax: (717) 408-4917
dlatzko@wilkes.edu
wilkes1.wilkes.edu/~dlatzko