International Trade: Theory and Evidence
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1 International Trade: Theory and Evidence Growth in world exports: % % % % % % LDC export growth:, rapidinasia, highly variable in Latin America, slow in Africa.
2 Figure 1. Growth of Merchandise Exports, index (1980=100) Other Developing Countries World Sub-Saharan Africa Source: IMF World Economic Outlook (WEO). 1 Excluding oil exports. Least Developed Countries Minerals Agriculture Manufactures Total Figure 2. Developing Countries: Share of Exports Going to Other Developing Countries, percent Source: Global Trade Analysis Project (GTAP) database, version 5. Figure 3. World: Product Composition of Merchandise Exports, percent Minerals Agriculture Manufactures Source: GTAP database, version 5.
3 Developing countries share of world trade:, 20% in 1980, 30% in 2005., BUT decline in share of sub saharan Africa (1% 0.5%) Composition of LDC exports has shifted towards manufacturing, now about 70% of total exports, mostlyduetoeastasia(esp.china), often a result of deliberate policies
4 Figure 4. Developing Countries: Composition of Merchandise Exports, Minerals percent Agriculture Manufactures Source: GTAP database, version 5.
5 Figure 6. Sub-Saharan Africa: Composition of Merchandise Exports, Minerals 60 percent Agriculture Manufactures Source: GTAP database, version 5.
6 Standard hypothesis of trade patterns: DCs Primary goods Manufactures LDCs, LDCs export proportionately more primary goods, BUT developed countries do not import proportionately more primary goods Why?, large fraction of DC trade is within DCs and is in manufactured goods
7 Actual World trade ßows DCs Primary Manu. Manufactures DCs Primary Manu. LDCs LDCs However, trade between LDCs has increased recently to about 10% of world trade
8 Why Do Countries Trade? 1. Comparative Advantage Ricardian Trade Theory Example:, 2 countries: North and South, 2 goods: Computers and Rice, 1 factor: labour 600 workers each
9 Technological assumptions: Labour One One sack Required Computer of Rice in North in South 40 20, North has an absolute advantage in both goods,, but a comparative advantage in computers., South has a comparative advantage in rice.
10 Production possibilities frontier In North: 10C N +15R N = 600, canbewrittenas R N = C N In South, canbewrittenas 40C S +20R S = 600 R S =30 2C S
11 Rice Rice 40 North South 30 2/ Computers 15 Computers 1.Production Possibilities
12 Autarky If both goods are consumed in North: p N c = 10 p N r 15 = 2 3. Why?, Competition p N c =10w c and p N r =15w r If pn c 10 >pn r 15, then w c >w r, all workers flow into computers.
13 If pn c 10 < pn r 15, then w c <w r, all workers flow into rice For both goods to be produced, we need w c = w r Similarly, if both goods are consumed in South: p S c p S r = =2.
14 Free Trade If both goods are going to be produced: 2 3 < p c p r < 2. Why? if p c p r < 2 3 < 2, both countries specialize in rice if p c p r > 2 > 2 3, both countries specialize in computers if 2 3 < p c p r < 2,, North specializes in computers, South specializes in rice.
15 If it is cheaper to produce rice in North, why don t people buy rice there?, market wages adjust so that rice is not cheaper in the North., as we move from autarky to free trade so that p N c p N r p S c p S r North : p N c 10 = wn > pn r 15 specialize in C South : p S c 40 <ws = ps r 20 specialize in C, effectively nullifies S s advantage in rice production.
16 Predictions of Ricardian Theory Each country specializes in the production of the goods in which it has a comparative advantage and exports them in return for other goods. All households in both countries are unambiguously better off with free trade than in autarky., the wage in both countries rises, consumption possibilities lie outside the production possibilities frontier Caveats only one factor of production labour is perfectly mobile across sectors competitive markets
17 Rice Rice p c /p r North South Consumption X Consumption M Production p c /p r 0 X Computers M Computers 2.Gains From Trade
18 2. Factor Endowments Neoclassical Trade Theory (Eli Heckscher and Bertil Ohlin) Example, 2 countries: North and South, 2 goods: Cars and Textiles, 2 factors: Capital (K) and Labour (L), identical preferences across countries North is relatively well endowed with K : K N L N > KS L S
19 Car production is capital intensive and textile production is labour intensive., given the same w/r. production isoquants are such that K/L for cars exceeds textiles Capital K c / L c Cars K T / L T w/r Textiles isocost line Labour 3.Capital Intensity
20 0 T C B Capital A 0 C Labour 4.Edgeworth box for North
21 Textiles A B C Cars 5.Production Possibilities Frontier for North
22 0 T E F Capital D 0 C Labour 6.Edgeworth Box for South
23 Textiles D E F Cars 7.PPF for South
24 Textiles N N p C /p T C Excess Demand P Excess Supply Cars 8.Disequilibrium in Autarky
25 Textiles T* E N N p C /p T C * Cars 9.Equilibrium under Autarky
26 S S p C /p T N N p C /p T 10.Autarky in North and South
27 p C /p T North p C /p T South C N M X P N C S P N X M 11.Free Trade Equilibrium
28 Implications of Neoclassical Trade Theory Under free trade the price ratio settles at a level between the two autarkic price ratios Incomplete specialization both countries produce both goods A country will tend to export the commodities that are intensive in factors that are possessed by that country in relative abundance., consistent with the standard hypothsis of DC LDC trade,, does not explain trade flows amongst OECD countries, model predicts a lot of trade between DCs and LDCs Households in both countries are potentially better off with free trade BUT there are distributional consequences
29 3. Differences in Preferences How do preferences differ between LDCs and DCs?, one hypothesis: DCs spend proportionately more on manufactured goods (luxuries), drives down relative price of primary goods as DCs get richer
30 Textiles Textiles p C /p T M X p C /p T X Cars M Cars 12.Trade due to differences in preferences
31 4. Economies of Scale Trade allows concentration of production in some coutries to maximize the effects of economies of scale Example:, 2 identical countries East and West, 2 goods ships and aircraft
32 $ $ Autarky AC AC A C Aircraft B D Ships 13.Trade and Specialization with Economies of Scale
33 The Gains and Losses from Trade Distributional Consequences of Trade Neoclassical theory potential gains due to increased goods/services BUT not necessarily actual gains to all members of society. Example (from earlier): Move toward free trade in North, increased (capital intensive) car production, reduced (labour intensive) textile production w/r falls, i.e. labour loses, capital gains Distribution of gains depends on distribution of factor ownership
34 Static vs. Dynamic Gains/Losses from Trade Comparative advantage is a static concept, but technologies and factor endowments change over time LDCs could allow trade patterns to change as they accumulate physical / human capital, natural shift from primary to manufacturing BUT may get stuck as primary producer and never invest enough to get beyond this stage
35 Why? Prebisch Singer Hypothesis, as world gets richer, fraction of income spent on primary products declines, long term deterioration in the terms of trade faced by many LDCs: T.o.T. = Export Price Index Import Price Index real incomes grow less rapidly, less capital accumulation / infrastructure Policy implication: need to protect / promote domestic manufacturing, may lower current income by distorting the gains from trade, but this is an investment which will raise future incomes.
36 Does this hypothesis make any sense? not necessary that world demand will go against primary products (e.g. coffee beans), BUT slow recovery from 60% decline in early 1980s, policy implication assumes that capital markets are not working properly, in a functioning capital market, high future returns in manfacturing should induce investment flow into it and away from primary production.
37 Figure 1. Evolution of non-oil commodity terms of trade Indices 1980 = 100; prices deflated by the unit value of manufactures exports from the G-5 countries to developing countries Developing countries Sub-Saharan Africa Table 1 World Bank commodity price indices for low and middle income countries (1990 =100) Jan-Dec 2002 Jan-Dec 2003 Jan-May 2004 Agriculture Beverages Food Fats and Oils Grains Other Food Source: : World Bank Global Economic Prospects 2004 (Appendix 2) : World Bank Commodity Price Data Pinksheet - June 2004
38 Figure 1.21 Commodity prices continued gains through 2007 led by metals Figure 1.22 Copper, zinc, and aluminum prices sharply affected by China Commodity price indexes (January ) Jan. 1, 2000 Jan. 1, 2001 Jan. 1, 2002 Metals Crude oil Agriculture Jan. 1, 2003 Jan. 1, 2004 Jan. 1, 2005 Jan. 1, 2006 Jan. 1, 2007 $/metric ton 9,000 Copper 8,000 7,000 6,000 5,000 4,000 3,000 2,000 Aluminum 1,000 Zinc 0 Jan. 3, 2000 Jan. 3, 2001 Jan. 3, 2002 Jan. 3, 2003 Jan. 3, 2004 Jan. 3, 2005 Jan. 3, 2006 Jan. 3, 2007 Source: World Bank. Sources: London Mercantile Exchange and World Bank.
39 Figure 1.25 Agricultural prices surge over Commodity price indexes ( ) 175 Raw materials Jan. 1, 2000 Figure 1.26 A rise in food price led by a ramp-up of the prices of fats, oils, and grains Commodity price indexes ( ) Jan. 1, 2000 Jan. 1, 2001 Jan. 1, 2001 Jan. 1, 2002 Source: World Bank. Jan. 1, 2002 Source: World Bank. Jan. 1, 2003 Grains Jan. 1, 2003 Beverages Food Jan. 1, 2004 Jan. 1, 2004 Jan. 1, 2005 Fats and oils Other foods Jan. 1, 2005 Jan. 1, 2006 Jan. 1, 2006 Jan. 1, 2007 Jan. 1, 2007 growing conditions in India, Pakistan, and Thailand improved, and new plantings and favorable weather boosted Brazilian production. Food prices have risen nearly 75 percent since their lows of The increases stem partly from the stepped-up use of food crops for biofuels and partly from other more fundamental factors, such as rapid income growth in developing countries, high fertilizer prices, low stocks, and droughts. Biofuels are playing an increasingly important role in agricultural commodity markets as their share of global production and trade increases. In 2006, biofuels accounted for 5 10 percent of the global production of the primary biofuel feedstocks and up to 77 percent of the volume of trade. Among the largest biofuel producers, the United States used 20 percent of its maize production for biofuels; Brazil used 50 percent of its sugarcane for biofuels; and the EU used 68 percent of its vegetable oil production, primarily rapeseed, and also imported additional vegetable oils. Such large usage reduces supplies of these crops for food and feed and has contributed to substantial price gains (box 1.2). The anticipated spike in grains prices, identified as a concern in the World Bank s Global Development Finance report published in May 2007 (World Bank 2007a), has largely materialized. Monthly wheat prices have increased 90 percent since mid Wheat stocks are expected to fall to record lows relative to consumption, and prices may increase further in 2008 before production recoups enough to rebuild stocks. In the meantime, a large number of food-importing countries may suffer substantial terms-of-trade losses over the course of 2007 and into 2008 (box 1.3). Price increases for vegetable oils and grains primarily affect low-income countries, with the rise in prices since the end of 2004 leading to a terms-of-trade loss equivalent to 0.5 percent of GDP. This represents 1 percent of GDP in 29 countries, and nearly 5 percent of GDP for the most affected country, Eritrea. The impact on middle- and high-income countries is considerably less because imports of these commodities represent a smaller share of trade, and higher prices on other commodity exports tends to offset terms-of-trade losses resulting from higher food prices. Agricultural prices are expected to remain nearly flat at high levels in 2008, as biofuels production continues to ramp up in response to consumption mandates and production subsidies, drawing resources from other crops.
40 BUT there are many market failures, imperfect capital markets create bias against future benefits relative to current costs., dynamic gains from investment may involve positive externalities, distribution of wealth, large country tariff argument may justify government intervention in the form of trade policy.
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