McGraw-Hill/Irwin Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 5: Who Chapter 5: Who Gains and Who Loses Gains and Who Loses

from Trade?from Trade?

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Within a countryWithin a country SR effects of opening tradeSR effects of opening trade

The US - exports wheat (price of wheat The US - exports wheat (price of wheat increases compared to pre-trade levels)increases compared to pre-trade levels) US winners: landlords in wheat production, US winners: landlords in wheat production,

wheat farm workerswheat farm workers US losers: US losers: cloth workers,cloth workers, landlords in cotton landlords in cotton

ROW – exports cloth (price increases) ROW – exports cloth (price increases) ROW winners: cloth workers, landlords in cotton ROW winners: cloth workers, landlords in cotton

and wool productionand wool production ROW losers: landlords in wheat production, wheat ROW losers: landlords in wheat production, wheat

farm workers farm workers

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LR factor-price response – factors move LR factor-price response – factors move between sectors in search of higher returns between sectors in search of higher returns (income gaps in SR)(income gaps in SR) In the US…In the US… Some US cloth workers will find jobs in wheat Some US cloth workers will find jobs in wheat

productionproduction Wages in wheat production will decline after the Wages in wheat production will decline after the

SR increase (how much?)SR increase (how much?) Wages in cloth production will increase after the Wages in cloth production will increase after the

initial decreaseinitial decrease Some land will be used for wheat instead of cotton Some land will be used for wheat instead of cotton

and wooland wool Rents on land used for wheat will decline after the Rents on land used for wheat will decline after the

initial increaseinitial increase Rents on land used for cotton will increase after Rents on land used for cotton will increase after

the initial declinethe initial decline

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Will wages and rents go back to their Will wages and rents go back to their pre-trade levels after the LR pre-trade levels after the LR adjustment?adjustment?

No!No! LR winners: US landowners and foreign LR winners: US landowners and foreign

workersworkers The price of land stays above pre-trade levels The price of land stays above pre-trade levels

in USin US The price of labour remains above pre-trade The price of labour remains above pre-trade

levels in ROWlevels in ROW LR losers: US workers and foreign LR losers: US workers and foreign

landownerslandowners Reason: wheat is more land intensive Reason: wheat is more land intensive

and cloth is more labour intensiveand cloth is more labour intensive

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Implications of the H-O Implications of the H-O theorytheory

The Stolper-Samuelson TheoremThe Stolper-Samuelson Theorem Trade changes product prices – wheat has a Trade changes product prices – wheat has a

higher relative price than pre-trade in UShigher relative price than pre-trade in US Real return to the factor used intensively in Real return to the factor used intensively in

the rising-price industry rises (land in wheat the rising-price industry rises (land in wheat production in the US)production in the US)

The real return to the factor used intensely in The real return to the factor used intensely in the falling-price industry falls (labour in cloth the falling-price industry falls (labour in cloth production in the US) production in the US)

This does not depend on how much of each This does not depend on how much of each product is consumedproduct is consumed

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The specialized-factor patternThe specialized-factor pattern The more a factor is specialized, or The more a factor is specialized, or

concentrated, in the production of a concentrated, in the production of a product whose relative price is rising, product whose relative price is rising, the more this factor stands to gain from the more this factor stands to gain from a change in the product pricea change in the product price

The more a factor is concentrated into The more a factor is concentrated into the production of a product whose the production of a product whose relative price is falling, the more it relative price is falling, the more it stands to lose from the change in the stands to lose from the change in the product priceproduct price

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The factor price equalization theoremThe factor price equalization theorem With time not only product prices equalize, With time not only product prices equalize,

but also factor prices (even if factors don’t but also factor prices (even if factors don’t move across countries)move across countries)

Workers earn the same wage rate in both Workers earn the same wage rate in both countriescountries Pre-trade wages in US are higher due to scarcityPre-trade wages in US are higher due to scarcity After trade wages declineAfter trade wages decline Pre-trade wages are lower in ROW (abundant) Pre-trade wages are lower in ROW (abundant) After-trade wages are higher (cloth-export)After-trade wages are higher (cloth-export)

Land earns the same return in both countriesLand earns the same return in both countries

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International Factor Price International Factor Price EqualizationEqualization

With the shift to free trade: For each factor, its With the shift to free trade: For each factor, its rate of return becomes more similar between rate of return becomes more similar between countries. Under ideal conditions, its real rate of countries. Under ideal conditions, its real rate of return is the same in different countries.return is the same in different countries.

Example: Labor.Example: Labor. With no trade, the wage rate is high in the labor-With no trade, the wage rate is high in the labor-

scarce country. The wage rate is low in the labor-scarce country. The wage rate is low in the labor-abundant country.abundant country.

With free trade, the import of labor-intensive With free trade, the import of labor-intensive products pushes the wage-rate down in the labor-products pushes the wage-rate down in the labor-scarce country. The export of labor-intensive scarce country. The export of labor-intensive products pulls the wage rate up in the labor-products pulls the wage rate up in the labor-abundant country.abundant country.

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H-O and actual trade H-O and actual trade patternspatterns

Factor endowments see tableFactor endowments see table International trade – see tableInternational trade – see table

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Figure 5.3 - Shares of the Figure 5.3 - Shares of the World’s Factor World’s Factor

Endowments, Early 2000sEndowments, Early 2000s

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Export-oriented and import-Export-oriented and import-competing factorscompeting factors

The US pattern – see tableThe US pattern – see table The Canadian pattern –see tableThe Canadian pattern –see table

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Figure 5.5 – A Schematic View Figure 5.5 – A Schematic View of the Factor Content of U.S. of the Factor Content of U.S.

Exports and Competing Exports and Competing ImportsImports

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Figure 5.6 - The Factor Figure 5.6 - The Factor Content of Canada’s Content of Canada’s

Exports and Competing Exports and Competing ImportsImports

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Do factor prices equalize Do factor prices equalize internationally??internationally??

The strong form of theorem is The strong form of theorem is subject to many assumptions and subject to many assumptions and conditions conditions

A weak form of the theorem – A weak form of the theorem – tendency of factor prices towards tendency of factor prices towards equalizationequalization

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International Factor Price International Factor Price Equalization Equalization

With the shift to free trade: For each factor, With the shift to free trade: For each factor, its rate of return becomes more similar its rate of return becomes more similar between countries. Under ideal conditions, between countries. Under ideal conditions, its real rate of return is the same in different its real rate of return is the same in different countries.countries.

Example: Labor.Example: Labor. With no trade, the wage rate is high in the With no trade, the wage rate is high in the

labor-scarce country. The wage rate is low labor-scarce country. The wage rate is low in the labor-abundant country.in the labor-abundant country.

With free trade, the import of labor-With free trade, the import of labor-intensive products pushes the wage rate intensive products pushes the wage rate down in the labor-scarce country. The down in the labor-scarce country. The export of labor-intensive products pulls the export of labor-intensive products pulls the wage rate up in the labor-abundant country.wage rate up in the labor-abundant country.

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