5.2. Introducing International Trade Flashcards
Trading in the H-O model
Home and Foreign are assumed to have the same technology and the same tastes:
- With the same technology, each economy has a comparative advantage in producing goods that relatively intensively uses the factors of production in which the country is relatively well endowed.
- With the same tastes, the two countries will consume cloth to food in the same ratio when faced with the same relative price of cloth under free trade.
Since cloth is relatively labour intensive, at each relative price of cloth to food, Home will produce a higher ratio of cloth to food than Foreign:
- Home will have a larger relative supply of cloth to food than Foreign.
- Home’s relative supply curve lies to the right of Foreign’s.
Relative prices and patterns of trade
The Heckscher-Ohlin model predicts a convergence of relative prices with trade:
- With trade, the relative price of cloth rises in Home (the relatively labour-abundant country) and falls in Foreign (the relatively labour-scarce country).
In home, the rise in the relative price of cloth leads to a rise in the relative production of cloth and a fall in the relative consumption of cloth, as Home becomes an exporter of cloth and an importer of food.
The decline in the relative price of cloth in Foreign leads it to become an importer of cloth and an exporter of food.
Heckscher-Ohlin theorem
The country that is abundant in a factor exports the good whose production is intensive in that factor.
Countries tend to export goods whose production is intensive in factors with which the countries are abundantly endowed.
Trade and distribution of income
Changes in relative prices can affect the earnings of labour and capital.
- A rise in the price of cloth raises the purchasing power of labour in terms of both goods, while lowering the purchasing power of capital, in terms of both goods.
- A rise in the price of food has the reverse effect.
Thus, international trade can affect the distribution of income, even in the long-run:
- Owners of a country’s abundant factors gain from trade, but owners of a country’s scarce factors lose.
Factors of production that are used intensively by the import-competing industry are hurt by the opening of trade, regardless of the industry in which they are employed.
Compared with the rest of the world, the US is abundantly endowed with highly skilled labour, while low-skilled labour is correspondingly scarce.
International trade has the potential to make low-skilled workers in the US worse off.
Economic change and income distribution
Changes in income distribution occur with every economic change, not only international trade:
- Changes in technology; changes in consumer preferences; exhaustion of resources and discovery of new ones all affect income distribution.
Economists put most of the blame on technological change and the resulting premium paid on education as the major cause of increasing income inequality in the US.
It would be better to compensate the losers from trade rather than prohibit trade, as the economy as a whole does benefit from trade.
There is a political bias in trade politics: the potential losers from trade are better politically organised than the winners from trade:
- Losses are usually concentrated among a few, but gains are usually dispersed among many.
North vs south trade and income inequality
Over the last 40 years, countries such as South Korea, Mexico and China have exported goods, such as clothing, shoes and toys, to the United States using unskilled labour.
At the same time, income inequality has increased in the United States, as wages of unskilled workers have grown slowly, compared to those of skilled workers.
The Heckscher-Ohlin model predicts that owners of relatively abundant factors will gain from trade and owners of relatively scarce factors will lose from trade.
According to the model, a change in the distribution of income occurs through changes in output prices, but there is no evidence of a change in the prices of skill-intensive goods relative to prices of unskilled-intensive goods.
According to the model, wages of unskilled workers should increase in unskilled labour abundant countries relative to wages of skilled labour, but in some cases, the reverse has occurred.
Wages of skilled labour have increased more rapidly than wages of unskilled labour.
Compared to the US and Canada, Mexico is supposed to be abundant in unskilled workers.
Even if the model were exactly correct, trade is a small fraction of the US economy so its effects on US prices and wage prices should be small.
The majority view of trade economists is that new production technologies, that cause redundancies, are the main ‘villain’ of international trade and job loss.
Skill-biassing
Even though skilled labour becomes relatively more expensive, producers in both sectors respond to the skill-biassed technological change by increasing their employment of skilled workers relative to unskilled workers.
A widespread increase in the skilled labour ratios for most sectors in the US economy points to the skill-biassed technological explanation.
Trade likely has been an indirect contributor to increases in wage inequality, by accelerating the process of technological change:
Firms that begin to export may upgrade to more skill-intensive production technologies.
Trade liberalisation can then generate widespread technological change by inducing a large proportion of firms to make such technology-upgrade choices.
Breaking up the production process across countries can increase the relative demand for skilled workers in developed countries, similar to skill-biassed technological change.
Capital-skill complementarity
The trend towards lower labour income shares and higher capital shares is a worldwide phenomenon.
This is experienced in labour-abundant countries, such as China and India, as well as capital-abundant countries, such as the US.
Evidence supports an explanation based on technological change within sectors, not increased import competition.
Technological change often takes the form of new and better capital that displace unskilled workers, but still require skilled workers:
This generates higher returns for both capital and skilled workers, while depressing the returns to unskilled workers.
Increased automation can explain the observed worldwide increases in both wage inequality and the returns to capital, as well as the within-sector increases in the employment share of non-production workers.
Factor price equilisation
Unlike the Ricardian model, the Hackscher-Ohlin model predicts that factor prices will be equalised among countries that trade.
Free trade equalises relative output prices.
Due to the connection between output prices and factor prices, factor prices are also equalised.
Trade increases the demand for goods produced by relatively abundant factors, raising the prices of the relatively abundant factors.
In the real world, factor prices are not equal across countries.
The model assumes that trading countries produce the same goods, but countries may produce different goods if their factor ratios radically differ.
The model also assumes that trading countries have the same technology, but different technologies could affect the productivity of factors and therefore the wages paid to these factors.
The model also assumes that trading countries have the same technology, but different technologies could affect the productivity of factors and therefore the wages paid to these factors.
The model also ignores trade barriers and transportation costs, which may prevent output prices and thus factor prices from equalising.
The model predicts outcomes for the long-run, but after an economy liberalises trade, factors of production may not quickly move to the industry that intensively use abundant factors:
- In the short-run, the productivity of factors will be determined by their use in their current industry, so that their wage rate may vary across countries.
