Lecture 12 International Trade. Noah Williams

Transcription

1 Lecture 12 International Trade Noah Williams University of Wisconsin - Madison Economics 702 Spring 2018

2 International Trade Two important reasons for international trade: Static ( microeconomic ) Different technologies: classic Ricardian comparative advantage Different factor endowments: Hecksher-Ohlin Specialization Results in simultaneous imports and exports. Dynamic ( macroeconomic ) Consumption smoothing Foreign investment Results in current account deficits and surpluses. Focus first on a small open economy. Later look at 2 country model.

3 A Static Small Open Economy Model To think about international trade, we first consider a two-good static model. Similar to the static labor-leisure model, but now with different consumption goods. Suppose there are two types of consumption goods a, b. Each good produced with a possibly different technology: a = F(K a, N a ) b = G(K b, N b ) Static model: suppose that capital is fixed in each sector. There is a total amount of labor to be allocated to each sector: N = N a + N b.

4 Production Possibilities Frontier As in the labor-leisure model the PPF gives the amount of one good that can be produced for a given amount of the other good. Here it can be found as: Then we have: a = F( K a, N a ) N a = F 1 (a; K a ) b(a) = G( K b, N N a ) = G( K b, N F 1 (a; K a )) Slope of the PPF gives the MRT a,b b (a) = G N ( K, 1 N b ) F N ( K a, N a ) So MRT a,b = G N /F N. So as N a N, then G N, so PPF becomes vertical. As N a 0, F N, so PPF becomes horizontal.

5 Figure 13.1 Production Possibilities Frontier for the SOE Copyright 2008 Pearson Addison-Wesley. All rights reserved. 13-4

6 Representative Consumer Suppose representative household supplies labor inelastically, has preferences over the two goods a, b: U (q a, q b ) As always, ratio of marginal utilities gives MRS: MRS a,b = U a U b Assume a small open economy, which means world prices are taken as given. The terms of trade give the relative (world) price of good a in terms of good b: TOT ab = p a p b

7 Household Problem Since labor supply is inelastic, can think of income to household as just output (a, b), so budget constraint is: p a q a + p b q b = p a a + p b b TOT a,b q a + q b = TOT a,b a + b Household maximizes utility by choosing (q a, q b ) subject to budget constraint. max U (q a, q b ) λ(tot a,b q a + q b TOT a,b a b) q a,q b First order conditions: U a = λtot a,b, U b = λ Or in other words, combining them: U a U b = MRS a,b = TOT a,b

8 Firm Problem and Equilibrium Firm maximizes profit by choosing overall labor input N and allocation of labor between sectors N a : [ max p a F( K a, N a ) + p b G( K ] b, N N a ) wn N,N a First order condition for N a : Or, rearranging: p a F N ( K a, N a ) = p b G N ( K b, N N a ) p a p b = TOT a,b = MRT a,b = G N /F N Conditions are similar to closed economy, but with trade production does not have to equal consumption. No trade: q a = a, q b = b.

9 Figure 13.3 Equilibrium in the SOE with No Trade Copyright 2008 Pearson Addison-Wesley. All rights reserved. 13-8

10 Figure 13.4 Production and Consumption in the SOE with Trade Copyright 2008 Pearson Addison-Wesley. All rights reserved

11 Trade, Welfare, and Terms of Trade The terms of trade determine which good is imported, which is exported. Trade always increases welfare. The no-trade allocation is always feasible. If it is not chosen, it must be because welfare is higher with trade. Changes in terms of trade may lead economy to switch from importing to exporting. Increase in terms of trade (increase in relative price of good a) decreases welfare when a is initially imported, increases welfare when good b is initially imported.

12 Figure 13.5 An Increase in Welfare When Good a Is Imported Copyright 2008 Pearson Addison-Wesley. All rights reserved

13 Figure 13.6 An Increase in Welfare When Good b Is Imported Copyright 2008 Pearson Addison-Wesley. All rights reserved

14 Figure 13.7 An Increase in the Terms of Trade when Good a Is Initially Imported Copyright 2008 Pearson Addison-Wesley. All rights reserved

15 Figure 13.8 An Increase in the Terms of Trade when Good b Is Initially Imported Copyright 2008 Pearson Addison-Wesley. All rights reserved

16 Terms of Trade and Trade Balance: US In GDP accounts, TOT is defined as price of exports relative to imports 75.0 Gross domestic product: Terms of trade index, Q1 1947=100 (left) Net Exports of Goods and Services (right) Index Billions of Dollars ,200 fred.stlouisfed.org myf.red/g/cv8c

17 Terms of Trade and Trade Balance: Chile

18 The Heckscher-Ohlin Model Appleyard & Field (& Cobb): Chapters 8 & 9 (Krugman & Obstfeld: Chapter 3 & 4) 1

19 Assumptions of the Heckscher-Ohlin- (Samuelson)-Model 1. Two countries, two (homogeneous) goods and two (homogeneous) factors of production 2. Identical technology, different factor endowments 3. Constant returns to scale 4. Different factor intensities in production 5. Factors perfectly mobile inside each country and immobile between the countries 6. (Identical preferences among everyone) 7. Perfect competition in all markets (price of labor) w = MP L *P, (price of capital) r = MP K *P 8. (No transportations costs) 2

20 Factor Endowments Countries differ in their relative factor endowments Notation: K=capital, L=labor, r = price of capital, w = price of labor Physical definition: (K/L) 1 > (K/L) 2 country 1 is capital-abundant (labor-scarce), country 2 is laborabundant (capital-scarce) Price definition: (r/w) 1 < (r/w) 2 country 1 is capital-abundant, country 2 is labor-abundant Given assumptions of perfect competition + identical technology and preferences, the physical and price definitions are identical 3

21 Factor Endowments Low K/L ratio High K/L ratio Capital (K) Capital (K) Labor (L) Labor (L) 4

22 Commodity Factor Intensity Good X is capitalintensive and good Y labor-intensive if K X /L X > K Y /L Y for all relative factor prices (r/w) the firm always maximizes profits / minimizes cost by using relatively more capital in producing X than in producing Y Capital Isoquant for X Isoquant for Y Labour 5

23 Gains from Trade in the Hecksher- Ohlin Model Notation: F = foreign H = home C=cloth P=paper A=autarky FT=free trade Capital Intensive Good (e.g. paper) PPF of foreign country Identical preferences in both countries (P C /P P ) F A (P C /P P ) F A > (P C /P P ) H A PPF of the home country (P C /P P ) H A Labor intensive Good (e.g clothes) Note that here foreign country looks like Finland and home like China 6

24 Gains from Trade in the Hecksher- Ohlin Model Notation: F = foreign H = home C=cloth P=paper A=autarky FT=free trade Capital Intensive Good (e.g. paper) (P C /P P ) F A (P C /P P ) F A > (P C /P P ) FT > (P C /P P ) H A (P C /P P ) H A (P C /P P ) FT trade trade Labor intensive Good (e.g clothes) 7

25 Heckscher-Ohlin Theorem Country will export the commodity that uses relatively intensively its relatively abundant factor of production i.e. what we saw in the previous graph example: China is labor-abundant and Finland is capital-abundant i.e. (K/L) H < (K/L) F and (r/w) H > (r/w) F China exports labor-intensive products (e.g. clothes) to Finland and imports capital-intensive products (e.g. paper) from Finland 8

26 Factor Price Equalization Autarky Free trade o relative prices of final goods become identical relative price of paper increases (=relative price of clothes decrease) in Finland e.g. Finland produces more paper, China more clothes Since producing paper is more capital intensive, demand for capital increases (demand curve shifts upwards) and demand for labour decreases (downwards) in Finland w r Similarly in China, demand for labor increases and demand for capital decreases r w In equilibrium all prices (including factor prices) are identical 9

27 Income Distribution and Trade: the Stolper-Samuelson Theorem Trade affects both the prices of goods and the prices of factors of production: What then is the impact of trade on distribution of real income? o wages decrease in Finland, but also the price of clothes decreases (i.e. you need less money to buy the same amount of clothes). Which effect dominates? Stolper-Samuelson Theorem: real income of the owners of abundant factor increases and the real income of owners of scarce factor decreases o Think about the labor abundant country (e.g. China): Free trade r w capital/labor ratio labor productivity real wages W. Stolper & P. Samuelson (1941): International Factor-Price Equalisation Once Again. Economic Journal 59, no

28 Why Don t We Observe Price Equalization? In reality most of the assumptions needed for price equalization do not hold o e.g. differences in productivity / technology, transportation costs, tariffs, subsidies, imperfect competition, unemployed resources, externalities However, the model provides an important insight on the tendency of price movements due to increasing international trade 11

29 Trade as a Substitute for Capital and Labour Flows Suppose that there is no international trade of goods, but capital and labour are internationally perfectly mobile Capital will then flow to the labor-abundant country and labor to the capital-abundant country until the factor prices are equal in both countries When all markets are perfectly competitive, this must imply equal commodity prices Trade and factor mobility are perfect substitutes in the HO-model R.A. Mundell (1957): International Trade and Factor Mobility. American Economic Review 47(3). 12

30 Summary of the Heckscher-Ohlin model Differences in relative endowments of factors of production Comparative advantage Trade leads to o Expansion of the industry using intensively the abundant factor of production (Heckscher-Ohlin Theorem) o Changes in distribution of income (international factor price equalization, Stolper-Samuelson theorem) 13

31 Is trade beneficial in the HO-Model? We have seen that trade benefits some* and hurts others**. So, do the gains outweigh the losses? To answer this question would require comparison of (subjective) welfares (do the losers suffer more than the winners enjoy), which is outside of the province of economic analysis. However, we can ask: Could those who gain compensate those who lose, and still be better off? The answer is, yes. Trade expands the economy s choices (enables consumption outside PPF). Hence, in principle, it is possible to redistribute income in such a way that everyone will gain. Of course, this is not to say that redistribution would actually happen. The presence of losers and winners in the real world is probably the most important reason why trade is not free. * owners of the abundant / export specific factor; ** owners of the scarce / import specific factor 14

32 Tariffs and Subsidies import tariffs and export subsidies affect terms of trade through their effect in relative supply and demand import tariffs make imported goods more expensive inside the country export subsidies raise the price of exported goods inside the country tariffs and subsidies affect internal prices, which are the prices used by producers and consumers at home although terms of trade correspond to external prices, tariffs and subsidies affect terms of trade because they affect the world relative supply and demand Home imposes a tariff on paper imports: internal relative price of paper increases; home producers of clothes decrease supply; home producers of paper increase supply; home consumers spend more in clothes than in paper; world supply of clothes falls and demand for clothes rises; world relative price of clothes rises In general, a tariff will make better off the factor used intensively in the import-competing sector at home, and will make worse off the factor used intensively in the exporting sector 15