3. Trade and Development

Transcription

1 Trade and Development Table of Contents a) Absolute cost advantage (Adam Smith) b) Comparative cost advantage (David Ricardo) c) Different factor endowments (Heckscher Ohlin) d) Distribution of gains from trade 135

2 Literature Brander, J. A. und Spencer B. J. (1985): Export Subsidies and International Market Share Rivalry, in: Journal of International Economics, 18, p Dollar and Kraay (2003), Institutions, trade and growth, Journal of Monetary Economics, Vol. 50. Frankel, J. A. and D. Romer (1999). Does trade cause growth? The American Economic Review, Vol. 89(3): pp Krugman, P. and M. Obstfeld (2004): International Economics Theory and Evidence, 6 th edition, Pearson/Addison Wesley: Boston, Mass. Magee, C.S.P. and S.P. Magee (2008), The United States is a small country in world trade, Review of International Economics, Vol. 16(5). Markusen, J. R., J.R. Melvin, W.H. Kaempfer and K.E. Maskus (1995), International Trade: Theory and Evidence, New York et al Rodriguez,F. and D. Rodrik (2000), Trade policy and economic growth : a skeptic's guide to the cross national evidence, NBER macroeconomics annual, Vol. 15, Winters, L.A. (2004), Trade liberalisation and economic performance: An overview, The Economic Journal, Vo. 114 (493). Winters, L.A., N. McCulloch, and A. McKay (2004), Trade liberalisation and poverty: The evidence so far, Journal of Economic Literature, Vol. 42(1). 136

3 Overview: Why do countries trade? climatic differences in world regions comparative cost differences different factor endowments (resources) benefits of specialization different preferences "Everyone does what he (relatively) does the best." "There is trade because it s worth it." 137

4 a) Absolute cost advantage (Adam Smith) countries specialize and engage in international trade because each country has an absolute advantage in the production of a particular good (or more goods). Example 1: country A has an absolute advantage in the production of steel (30>10). Country B has an absolute advantage in the production of tea (50>5). Table 5: Production possibilities per worker per year Country A Country B Steel in tons Tea in tons

5 a) Absolute cost advantage (Adam Smith) both products are required in both countries. In autarky the countries would have to divide the available labor into the production of both goods. through specialization and trade the total output and hence the consumption possibilities could be increased in both countries. through specialization the global steel production can be increased by 20 tons and the global tea production by 45 tons. both countries benefit from trade. Country A exports steel to country B and in turn imports tea from country B and vice versa. 139

6 b) Comparative cost advantage (David Ricardo) countries specialize in the production of goods for which they have comparative cost advantages (due to a different factor productivity in the production of various goods) compared to other countries. countries even benefit from specialization in the case in which one country has absolute cost advantages in the production of all goods. It is only important that each country has a comparative advantage in the production of at least one good. trade is also worth it between very different countries, even if one country does not belong to the best in any sector, i.e. if the country has absolute cost disadvantages in the production of all goods. Table 6: Production possibilities per worker per year Country A Country B Steel in tons Tea in tons

7 b) Comparative cost advantage (David Ricardo) the argument for the identification of any comparative advantage is closely linked to the concept of opportunity costs. Question: How many tons of steel does country A have to sacrifice in order to produce one additional ton of tea? Response: Country A would have to sacrifice 2 tons of steel in order to produce one ton of tea (20/10). The opportunity cost of one ton of tea are thus 2 tons of steel. Country B, however, would have to "sacrifice" only 0.5 tons of steel to produce one additional ton of tea. 141

8 b) Comparative cost advantage (David Ricardo) country A therefore has a comparative advantage in the production of steel in comparison to country B. The opportunity costs of the steel production are higher in country B compared to country A. country B therefore has a comparative disadvantage in the production of tea compared to country A, although in absolute terms country B is "better" in the production of both goods. also in this case the entire output can be increased through specialization and trade. 142

9 b) Comparative cost advantage (David Ricardo) the impact of the relocation of two workers in country A from the tea production to the steel production and the relocation of one worker in country B from the steel production to the tea production are represented by Table 8. both countries benefit from specialization and the incipient trade. Country A exports steel, while country B exports tea. Table 7: Impact of the relocation of labor Country A Country B Total Steel in tons Tea in tons

10 b) Comparative cost advantage (David Ricardo) Model principles/assumptions: 2 countries, 2 goods, one production factor (labor), different labor productivity, constant returns to scale, labor internationally immobile but sectorally mobile, Labor coefficients (How many hours are needed to produce one unit of a good) are different in each country. The production factors are limited in both countries. If the production of one good shall increase, it can only be produced less of the other good (i.e. one always moves/stays on the transaction curve (TC)). 144

11 b) Comparative cost advantage (David Ricardo) The assumptions lead to the following conclusions: Due to the constant returns to scale with only one production factor one receives a straight line for the transaction curve (maximum output). Since the relative prices are different, it is worth trading. In the example, the relative price of steel is lower in country A than in country B (according to that, the relative price of tea is higher in country A than in country B), it is worthwhile for country A to export steel (and to import tea) and correspondingly for country B it is worthwhile to import steel and to export tea. 145

12 b) Comparative cost advantage (David Ricardo) The assumptions lead to the following conclusions: through trading the relative prices approach each other. In the example the relative price of steel in country A will rise (due to a low price and high demand) and decrease in country B (low demand for expensive steel), correspondingly vice versa for tea. Due to this change in prices in favor of the sector with the comparative advantage, this sector will expand in the respective country, while the other sector is shrinking. The price change will last until the relative prices are identical in the two countries. The price must level off so that the quantities of exports and imports of the particular good correspond each other in both countries. 146

13 b) Comparative cost advantage (David Ricardo) Figure 8: Autarky and free trade equilibrium in the Ricardo Model Country A (specialization in steel production) Country B (specialization in tea production) 147

14 b) Comparative cost advantage (David Ricardo) In summary: Countries specialize according to comparative advantage in production determined by labor productivity. Gains from trade: Free trade enlarges consumption capacities and increase world production. trade as an indirect method of production 148

15 c) Different factor endowments (Heckscher Ohlin) Even in the case of identical technologies (same factor productivity) specialization and trade are profitable, if the countries / regions differ in terms of their factor endowment (land, capital) Assumptions: two countries, two goods, two input factors (e.g. labor and capital) identical technologies, identical homothetic consumer preferences differences in factor endowments (e.g. one country is more labor abundant) differences in factor intensities (e.g. one good is more labor intensive) mobility of inputs within a country (between sectors) but not between countries consumer maximize utility with respect to budget constraint 149

16 c) Different factor endowments (Heckscher Ohlin) Heckscher Ohlin Theorem: Relation between endowment and specialization A country will export the good in which it has a comparative advantage based on its resource endowments. A relatively higher endowment of one factor compared to a foreign country is associated with a lower relative factor price and, thus, a lower relative price. 150

17 c) Different factor endowments (Heckscher Ohlin) Different factor endowments cause different relative factor prices: The price for work is ceteris paribus in regions, where much of this factor is available, relatively low and the price of capital (i.e. interest rates) is relatively low in regions with high capital endowment. The production of various goods requires e.g. due to technological reasons different factor proportions. The production of textiles, for example, requires a relatively high use of labor. The production is therefore "labor intensive". Modern industrial products (machinery) are generally produced "capital intensive". 151

18 c) Different factor endowments (Heckscher Ohlin) Through trading the prices of goods assimilate. Countries with a relatively high level of capital endowment (capital costs are relatively low) specialize in the production of capital intensive goods (e.g. machinery), countries with relatively much work (relatively low wages) mainly produce textiles. All countries benefit from specialization and trade. Through the concave shape of the transaction curve, no country fully specializes in the production of that good for which it has comparative advantages. 152

19 c) Different factor endowments (Heckscher Ohlin) Figure 9: Autarky and free trade equilibrium in the Heckscher Ohlin Model 153

20 Distribution of gains from trade Convergence of factor prices There is a convergence of factor prices between trading countries. That is, work in the country with the "labor intensive" specialization becomes more expensive, in the country with the "capital intensive" specialization labor becomes cheaper. On the contrary capital in the capital rich country becomes more expensive, in the capital poor country it becomes cheaper. As a result, the owners of the factor that is used intensively benefit more from this development. Specialization and trade thus tend to lead to a more even distribution of income 154

21 Distribution of gains from trade Stolper Samuelson Theorem: relation between factor prices and goods prices Factor price equalization due to free trade: A change in relative prices has a strong effect on the income distribution. An increase in relative prices (due to trade) will raise the income of the factor which is intensively employed in production of that good. The other factor will be worse off due to free trade. 155

22 Distribution of gains from trade In summary: Countries specialize according to comparative advantage in production determined by relative resource endowments gains from trade: larger consumption capacities and higher world production distribution of gains: abundant factor will gain while scarce factor will lose But: Winners are able to compensate losers Who will lobby for protection? What about income distribution when factors are immobile across sectors? (i.e. labor or human capital: Adjusting knowledge takes time) 156

23 Distribution of gains from trade Ricardo Viner Model Assumptions: two countries, two goods, two input factors (e.g. labor and capital) identical technologies identical homothetic consumer preferences differences in factor endowments (e.g. one country is more labor abundant) differences in factor intensities (e.g. one good is more labor intensive) New: one input factor is immobile between sectors e.g. capital is specific 157

24 Distribution of gains from trade Ricardo Viner Model Free trade: Specialising in production of the good for which the specific factor is relatively abundant (e.g. capital in export industry > capital in import industry). increase in relative price of the export good (, export sector expands, import sector contracts ( sector) demand for labor in production of the export good increases, nominal wage increase Labor movements until wage equalized in both sectors (full employment). 158

25 Distribution of gains from trade Ricardo Viner Model Figure 10: Free trade and income distribution in the Ricardo Viner Model 159

26 Distribution of gains from trade Ricardo Viner Model The effects on the mobile factor are ambiguous labor productivity in each sector: while marginal return to labor is ambiguous: real wage decrease in production while the real wage increases in production 0 160

27 Distribution of gains from trade Ricardo Viner Model Specific factors in export industry gain while specific factors in import industry lose capital productivity in each sector: while marginal returns to the specific factors: real rental rate for capital increases rental rate for capital decreases and and while real 0 161

28 Distribution of gains from trade Ricardo Viner Model A change in relative prices has strong effects on income distribution: An increase in relative prices (of export goods) will raise the income of the factor that is specific to the export industry. Owners of the specific factor in the import industry will be worse off. The assumption of mobility of labor leads to ambiguous results with respect to the purchasing power of income. Gains from trade: Winners are able to compensate losers. Who will lobby for protection? Interests are not factor specific (labor or capital) but rather industry specific (import vs. export industry). 162

29 Summary: Arguments for free trade and development Trade is important for economic growth: Enlargement of a country s consumption capacities, Increase in world output. efficient use of resource endowments access to scarce resources (embodied in imported goods) achieving development by specialization according to comparative advantage (differences in technology, resource endowments) outward looking policy 163

30 Summary: Arguments for free trade and development (I) Criticism on the argument of free trade Several assumptions of the models do not hold in reality e.g. resources fixed in quantity and quality, full employment condition mobility of factors between sectors in the economy perfect competition (risks and uncertainties in production, economies of scale) fixed technology (Ricardo), technology available to all countries (Heckscher Ohlin) Government is not considered, prices set by forces of demand and supply 164

31 Summary: Arguments for free trade and development (II) Income distribution affected by free trade: Ricardo: only one production factor, labor, all workers will be better off Heckscher Ohlin: Abundant factor will be better off, the scarce factor will lose. Ricardo Viner: Specific factors in the export industry will be better off, specific factors in the import competing industry will lose. 165