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AA 2018-2019
PROF. PIERLUIGI [email protected]
INTERNATIONAL TRADE: THEORY AND POLICY (HO)
EU TRADE POLICY FOR DEVELOPMENT
JEAN MONNET CHAIR
KEY POINTS of the Ricardian Model
1. the pattern of trade is determined by comparative advantage.
• A country has comparative advantage in producing a good when the country’s opportunity cost of producing the good is lower than the opportunity cost of producing the good in another country.
• Even countries with poor technologies can export the goods in which they have comparative advantage
2. There are gains from trade for both countries.
• By exporting the good in which a country has the lowest opportunity cost, the country could benefit from participating in international trade (i.e. more consumption)
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Repetita iuvant
Revealed comparative advantage
RCA index (Balassa, 1965). It is a ratio of
product k’s share in country i ’s exports (X) to its share in world trade.
A value of the RCA above 1 in sector k for country i means that i has a revealed comparative advantage in that sector (relative to the ROW)
Advantage: ability to derive a workable measure of each country’s comparative advantages as they are revealed in trade data, avoiding difficulties linked to quantitative evaluations of factor-endowments and relative prices.
Main drawback: just exports; asymmetric behavior between comparative advantagesand disadvantages. It ranges from 1 to infinity for products in which a country revealscomparative advantage, but only from zero to 1 for comparative disadvantage
The Heckscher-Ohlin Model
Why countries trade
An overview of trade theories:
The Heckscher-Ohlin Model
The Heckscher-Ohlin model assumes that trade occurs because countries have different resources.
The HO model is a long-run model because all factors of production can move across industries.
The model investigates also the gains from trade (i.e., the earnings of labor and capital in partner countries)
Heckscher-Ohlin Model
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
• The model was developed in 1919 by two Swedish economists, Eli Heckscher and BertilOhlin
• To explain the “golden age” of international trade between 1890 and 1914, during which there was an increase in the ratio of trade to gross domestic product (GDP)
• By assuming the same technologies acrosscountries they are able to explain trade by uneven distribution of resources
Examples of international trade driven by different resources
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
• Canada has a large amount of land and therefore exports agricultural and forestry products as well as petroleum
• US, Western Europe and Japan have many highly skilled workers and much capital and export sophisticated services and manufactured goods
• China and other Asian countries have a large number of workers and moderate but growing amounts of capital and export less sophisticated manufactured goods
Heckscher-Ohlin Model
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Basic assumptions:
• 2 countries: Home and Foreign
• 2 goods: computers and shoes
• 2 factors of production: labor and capital
The total amount of capital (K) in an economy is given by the sum of the capitalused in shoes KS and computers KC.
The total available labor (L) in the economy is equal to the labor used in shoesLS and computers LC.
The SIX assumptions of the Heckscher-Ohlin model are the following:
Assumption 1: the two factors of production, labor and capital, can movefreely between the industries.
Assumption 2: Shoes production is labor-intensive; that is, it requires morelabor per unit of capital to produce shoes than computers, so that
LS /KS > LC /KC.
Heckscher-Ohlin Model
Assumption 3: Foreign is labor-abundant, by which we mean that the labor–capital ratio in Foreign exceeds that in Home, L*/K*> L/K.
Equivalently, Home is capital-abundant, so that K/L >K*/L* (i.e. resources differ across countries).
• Why?
• Geographic size, populations, immigration/emigration, different stage of development, etc.)
Assumption 4: The final outputs, shoes and computers, can be traded freely (i.e., without any restrictions) between nations, but labor and capital do not move between countries.
Assumption 5: The technologies used to produce the two goods are identical across the countries (the opposite of that in the Ricardian model).
Assumption 6: Consumer tastes are the same across countries, and preferences for computers and shoes do not vary with a country’s level of income.
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
PPFs
1 PF
Constant OC
2 PFs
Increasing OC
2 PFs
Decreasing
OC
X
100
100
100 100
100 100
20 20 20
80 80 80
20 80 75 95 5 40
A
B
A
B
A
B
Y
Pierluigi Montalbano – Università di Roma “La Sapienza”
Derivazione della Curva FPP in presenza di Fattori Specifici
Pierluigi Montalbano – Università di Roma “La Sapienza”
No-Trade EquilibriumProduction Possibilities Frontiers, Indifference Curves, and
No-Trade Equilibrium Price
FIGURE 4-2 (1 of 3)
The Home production possibilities
frontier (PPF) is shown in panel (a),
and the Foreign PPF is shown in
panel (b).
Because Home is capital
abundant and computers are
capital intensive, the Home
PPF is skewed toward
computers.
Heckscher-Ohlin Model
No-Trade Equilibria in Home and Foreign
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
The Home Country
FIGURE 3-2
Production Possibilities Frontier
Production Possibilities Frontier
The production possibilities frontier shows the amount of
agricultural and manufacturing outputs that can be produced in
the economy with labor.
© 2014 Worth Publishers International Economics, 3e | Feenstra/Taylor
14
Its slope equals –MPLA/MPLM, the ratio of the
marginal products of labor in the two industries. The
slope of the PPF can be interpreted as the opportunity
cost of the manufacturing output—it is the amount of
the agricultural good that would need to be given up
to obtain one more unit of output in the
manufacturing sector.
The Home Country
FIGURE 3-3
In the absence of international trade, the economy produces and consumes
at point A.
The relative price of manufactures, PM/PA, is the slope of the line tangent
to the PPF and indifference curve U1, at point A.
With international trade, the economy is able to produce at point B and
consume at point C.
The world relative price of manufactures, (PM/PA)W, is the slope of
the line BC.
The rise in utility from U1 to U2 is a measure of the gains from trade for
the economy.
Opportunity Cost and Prices
© 2014 Worth Publishers International Economics, 3e | Feenstra/Taylor
15
Increase in the Relative Price of Manufactures
Our goal is to show how:
The relative abundance of factors of a country determines both relative prices of goods and patterns of trade (H-O Model)
The opening of trade between two countries affects the payments to factors of production ( Stolper-Samuelson Theorem)
Heckscher-Ohlin Model
No-Trade EquilibriumProduction Possibilities Frontiers, Indifference Curves, and
No-Trade Equilibrium Price
FIGURE 4-2 (2 of 3)
Home preferences are summarized
by the indifference curve, U.
The Home no-trade (or autarky)
equilibrium is at point A.
The flat slope indicates a low
relative price of computers,
(PC /PS)A.
Heckscher-Ohlin Model
No-Trade Equilibria in Home and Foreign (continued)
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
No-Trade EquilibriumProduction Possibilities Frontiers, Indifference Curves, and
No-Trade Equilibrium Price
FIGURE 4-2 (3 of 3)
No-Trade Equilibria in Home and Foreign
(continued)
Foreign is labor-abundant and shoes are
labor- intensive, so the Foreign PPF is
skewed toward shoes.
Foreign preferences are summarized
by the indifference curve, U*
The Foreign no-trade equilibrium is at
point A*, with a higher relative price
of computers, as indicated by the
steeper slope of (P*C /P*S)A*.
Heckscher-Ohlin Model
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
A higher relative price of computers
Free-Trade EquilibriumHome Equilibrium with Free Trade
FIGURE 4-3 (1 of 2)
At the free-trade world relative price of
computers, (PC /PS)W,
Home produces at point B in panel (a) and
consumes at point C,
exporting computers and importing shoes.
Point A is the no-trade equilibrium.
The “trade triangle” has a base equal to
the Home exports of computers (the
difference between the amount produced
and the amount consumed with trade,
(QC2 − QC3).
International Free-Trade Equilibrium at Home
Heckscher-Ohlin Model
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Free-Trade EquilibriumHome Equilibrium with Free Trade
FIGURE 4-3 (2 of 2)
The height of this triangle is the Home
imports of shoes (the difference between
the amount consumed of shoes and the
amount produced with trade, QS3 − QS2).
.
International Free-Trade Equilibrium at Home (continued)
Heckscher-Ohlin Model
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Free-Trade EquilibriumForeign Equilibrium with Free Trade
FIGURE 4-4 (1 of 2)
At the free-trade world relative price of
computers, (PC /PS)W,
Foreign produces at point B* in panel (a) and
consumes at point C*,
importing computers and exporting shoes.
Point A* is the no-trade equilibrium.)
The “trade triangle” has a base equal to
Foreign imports of computers (the
difference between the consumption of
computers and the amount produced with
trade, (Q*C3 − Q*C2).
Heckscher-Ohlin Model
International Free-Trade Equilibrium in Foreign
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Free-Trade EquilibriumForeign Equilibrium with Free Trade
FIGURE 4-4 (2 of 2)
The height of this triangle is Foreign
exports of shoes (the difference
between the production of shoes and
the amount consumed with trade, Q*S2
– Q*S3).
.
Heckscher-Ohlin Model
International Free-Trade Equilibrium in Foreign (continued)
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
Free-Trade Equilibrium
Pattern of Trade
• Home exports computers, the good that uses intensively the factor of production (capital) found in abundance at Home.
• Foreign exports shoes, the good that uses intensively the factor of production (labor) found in abundance there.
• This important result is called the Heckscher-Ohlin theorem.
Heckscher-Ohlin Model
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
You might think that the H-O theorem is somewhat obvious. However, this prediction does not always work in practice
The first test of the Heckscher-Ohlin theorem was performed by economist Wassily Leontief in 1953 using data for the US from 1947.
A surprising conclusion!
From the HO theorem, Leontief expected that the United States would export capital-intensive goods and import labor-intensive goods.
What Leontief actually found, however, was just the opposite: the capital–labor ratio for U.S. imports was higher than the capital–labor ratio found for U.S. exports!
This finding contradicted the Heckscher-Ohlin theorem and came to be called Leontief’s paradox.
Testing the Heckscher-Ohlin Model
© 2014 Worth Publishers International Economics, 3e | Feenstra/Taylor
25
TABLE 4-1
Leontief used the numbers in this table to test the Heckscher-Ohlin theorem.
Each column shows the amount of capital or labor used in all industries needed to produce $1 million worth of exports from, or imports into, the United States in 1947.
As shown in the last row, the capital–labor ratio for exports was less than the capital–labor ratio for imports, which is a paradoxical finding.
Leontief’s Paradox
Leontief’s Test
Testing the Heckscher-Ohlin Model
Leontief’s Paradox
Explanations
■ U.S. and foreign technologies are not the same, in contrast to what the HO theorem and Leontief assumed.
■ By focusing only on labor and capital, Leontief ignored land abundance in the United States (US exports might have been agricultural products, which use land intensively)
■ Leontief should have distinguished between skilled and unskilled labor (because it would not be surprising to find that U.S. exports are intensive in skilled labor).
■ The data for 1947 may be unusual because World War II had ended just two years earlier.
■ The United States was not engaged in completely free trade, as the Heckscher-Ohlin theorem assumes.
Testing the Heckscher-Ohlin Model
Differing Productivities across Countries
Remember that in the original formulation of the paradox, Leontief had found that the United States was exporting labor-intensive products even though it was capital-abundant at that time.
One explanation for this outcome would be that labor is highly productive in the United States and less productive in the rest of the world.
Hence:
• Differences in factors productivity (technologies were not the same across countries)
• The pattern of 1947 simply reflects the high producivity of labor in the US and its abundance
• The US was abundant in both capital and (skilled) labor
Testing the Heckscher-Ohlin Model
To obtain better predictions from the H-O model, wehave to extend it in several directions:
1. first by allowing for more than two factors of production
2. and second by allowing countries to differ in theirtechnologies
Both extensions make the predictions match more closely the trade patterns we see in the world economy today…
Testing the Heckscher-Ohlin Model
Factor Endowments in the New Millennium
To determine whether a country is abundant in a certain
factor, we compare the country’s share of that factor with
its share of world GDP.
If its share of a factor exceeds its share of world GDP, then
we conclude that the country is abundant in that factor,
and if its share in a certain factor is less than its share of
world GDP, then we conclude that the country is scarce in
that factor.
2 Testing the Heckscher-Ohlin Model
Capital, Labor and Land Abundance
Factor Endowments in the New Millennium
FIGURE 4-6
Country Factor
Endowments, 2013
Shown here are
country shares of six
factors of production
in the year 2013, for
eight selected
countries and the rest
of the world.
In the first bar graph, we see that 24% of the world’s physical capital in 2013
was located in the United States, with 9% located in China, 13% located in
Japan, and so on. In the final bar graph, we see that in 2013 the United States
had 22% of world GDP, China had 11%, Japan had 8%, and so on.
2 Testing the Heckscher-Ohlin Model
Differing Productivities across Countries
Remember that in the original formulation of the paradox,
Leontief had found that the United States was exporting
labor-intensive products even though it was capital-
abundant at that time.
One explanation for this outcome would be that labor is
highly productive in the United States and less productive
in the rest of the world.
If that is the case, then the effective labor force in the
United States, the labor force times its productivity (which
measures how much output the labor force can produce),
is much larger than it appears to be when we just count
people.
2 Testing the Heckscher-Ohlin Model
Differing Productivities across Countries
Measuring Factor Abundance Once Again To allow
factors of production to differ in their productivities across
countries, we define the effective factor endowment as
the actual amount of a factor found in a country times its
productivity:
Effective factor endowment = Actual factor endowment •
Factor productivity
2 Testing the Heckscher-Ohlin Model
Differing Productivities across Countries
Measuring Factor Abundance Once Again
To determine whether a country is abundant in a certain
factor, we compare the country’s share of that effective
factor with its share of world GDP.
If its share of an effective factor exceeds its share of world
GDP, then we conclude that the country is abundant in
that effective factor; if its share of an effective factor is
less than its share of world GDP, then we conclude that
the country is scarce in that effective factor.
2 Testing the Heckscher-Ohlin Model
E.g.: Effective R&D Scientists
Effective R&D scientists =
Actual R&D scientists • R&D spending per scientist
Differing Productivities across CountriesFIGURE 4-7 (1 of 2)
Shown here are country
shares of R&D scientists
and land in 2013, using
first the information from
Figure 4.6, and then
making an adjustment
for the productivity of
each factor across
countries to obtain the
“effective” shares.
China was abundant in R&D scientists in 2013 (since it had 14% of the world’s
R&D scientists as compared with 11% of the world’s GDP) but scarce in
effective R&D scientists (because it had 7% of the world’s effective R&D
scientists as compared with 11% of the world’s GDP).
2 Testing the Heckscher-Ohlin Model
“Effective” Factor Endowments, 2000
Differing Productivities across CountriesFIGURE 4-7 (2 of 2)
Shown here are country
shares of R&D scientists
and land in 2013, using
first the information from
Figure 4.6, and then
making an adjustment
for the productivity of
each factor across
countries to obtain the
“effective” shares.
The United States was scarce in arable land when using the number of acres
(since it had 13% of the world’s land as compared with 22% of the world’s GDP)
but neither scarce nor abundant in effective land (since it had 21% of the
world’s effective land, which nearly equaled its share of the world’s GDP).
2 Testing the Heckscher-Ohlin Model
“Effective” Factor Endowments, 2000
Leontief’s Paradox Once Again
FIGURE 4-8
Shown here are the share of
labor, “effective” labor, and GDP
of the US and the rest of the
world in 1947. The US had only
8% of the world’s population, as
compared to 37% of the world’s
GDP, so it was very scarce in
labor. But when we measure
effective labor by the total
wages paid in each country,
then the United States had 43%
of the world’s effective labor as
compared to 37% of GDP, so it
was abundant in effective labor.
Labor Abundance
2 Testing the Heckscher-Ohlin Model
Labor Endowment and GDP for the United States and Rest of World, 1947
Leontief’s Paradox Once AgainLabor Productivity
FIGURE 4-9
Shown here are estimated
labor productivities across
countries, and their
wages, relative to the
United States in 1990.
Notice that the labor and
wages were highly
correlated across
countries: the points
roughly line up along the
45-degree line.
2 Testing the Heckscher-Ohlin Model
Labor Productivity and Wages
Leontief’s Paradox Once AgainLabor Productivity
FIGURE 4-9 (revisited)
As suggested by Figure 4-
9, wages across countries
are strongly correlated
with the productivity of
labor. We use the wages
earned by labor to
measure the productivity
of labor in each country.
Then the effective amount
of labor found in each
country equals the actual
amount of labor times the
wage.
2 Testing the Heckscher-Ohlin Model
Effective Labor Abundance
Effects of Trade on Factor Prices
How do the changes in the relative prices of goods due to tradeaffect the factors’ earnings?
• The Stolper-Samuelson Theorem provides an answer to the above question.
Stolper-Samuelson Theorem: In the long run, when all factors are mobile, an increase in the relative price of a good will increase the real earnings of the factor used intensively in the production of that good and decrease the real earnings of the other factor.
For our example, the Stolper-Samuelson theorem predicts that when Home opens to trade and faces a higher relative price of computers, the real rental on capital in Home risesand the real wage in Home falls. In Foreign, the changes in real factor prices are just the reverse.
Effects of Trade on Factor Prices
Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers
1. In the Heckscher-Ohlin model countries trade because the available resources (labor, capital, and land) differ across countries.
2. In the Heckscher-Ohlin model, we assume that the technologies are the same across countries
3. The Heckscher-Ohlin model is a long-run framework, so labor, capital, and other resources can move freely between the industries
4. Patterns of trade: With two goods, two factors, and two countries, the Heckscher-Ohlin model predicts that a country will export the good that uses its abundant factor intensively and import the other good.
K e y T e r m KEY POINTS of the Heckscher-Ohlin model
K e y T e r m KEY POINTS of the Heckscher-Ohlin model
5. According to the Stolper-Samuelson theorem, in the long run, an increase in the relative price of a good will increase the real earnings of the factor used intensively in the production of that good and decrease the real earnings of the other factor.
6. Putting together the Heckscher-Ohlin theorem and the Stolper-Samuelson theorem, we conclude that a country’s abundant factor gains from the opening of trade (because the relative price of exports goes up), and its scarce factor loses from the opening of trade.