Lecture 2 - Winners and Losers from International Trade
from last time
winners and losers within a country
factor price equalization theorem
trade and income inequality
trade and jobs
trade and technology
From Last Time
How is the world price determined? By supply and demand in the international trade market.
The world price equates the demand for imports with the supply of exports.
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.
|Suppose 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.|
- growth must be biased towards export sector
- demand for the exports must be price inelastic so that the increase in supply causes a large fall in price
- country must be already heavily exporting the good so that the fall in price offsets the gains from the increase in supply
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.|
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.
- U.S. exports wheat and imports cloth
- the price of wheat rises and cloth prices fall in the U.S.
- the U.S. produces more wheat and less cloth
- shifts in the demand for factors of production
- wheat: big increase in the demand for land and an increase in the demand for labor
- cloth: decrease in the demand for land and a big decrease in the demand for labor
- in the short run, factors are unable to move between sectors
- rise in rents on wheat-growing land; rise in wages for farm workers
- fall in rents on cotton-growing land; fall in wages for textile workers
- in the long run, factors are mobile between sectors
- rise in rents on all land (compared to pre-trade levels)
- fall in wages for all workers (compared to pre-trade levels)
- in the rest of the world, opposite changes happen so that rents fall and wages rise in the rest of the world in the long run
So, some are absolutely better off and some worse off as a result of free trade.
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.
- 2 goods (wheat and cloth)
- 2 factors of production (land and labor)
- perfect competition
- wheat is land-intensive and cloth is labor-intensive
- factors are mobile between sectors but not countries
- trade raises the relative price of wheat
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
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.
- 2 factors of production (land & labor), 2 commodities, and 2 countries
- factor supplies are fixed and immobile between countries
- full employment
- no transportation costs
- no tariffs or other barriers to trade
- production functions for each industry are the same between countries
- no economies of scale
- factor-intensities are the same at all factor-price ratios
- both countries always produce both goods
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.
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.
Therefore, raising trade barriers will bring a net loss of U.S. jobs.
- exports use importable inputs
- foreigners who lose our business cannot buy so much from us
- foreign governments may retaliate
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.