EC4371 Chapter 3 Flashcards
What are the three tests of the Ricardian trade theory?
Type-I hypothesis
Express in terms of comparative unit labour costs
Comparative advantage belongs to country with lower comparative unit labour cost
Example:
Type-II hypothesis
Express in terms of comparative labour productivites
Comparative advantage belongs to country with higher comparative labour productivity
Example: McGilray and Anderson (Ireland and UK, paper)
Type-III hypothesis
Express in terms of comparative labour productivities, with a relative wage separating exports from imports
Example: MacDougall!!!! (US and UK, presentation and textbook)
Example: McGilray and Simpson (Ireland and UK, textbook)
Discuss MacDougall’s tests of the Ricardian theory.
Data
Pre-WWII data from US and UK manufacturing industries
Investigated the effect of relative labour productivity and relative wages on exports / trade pattern
TYPE-III HYPOTHESIS
Hypothesis
Relative wage cost per unit output is negatively correlated with export quantity
Relative prices are negatively correlated with relative export quantity
Methodology
Relative values obtained by dividing US figures by UK figures
Separate into three categories
- those in which US has relatively higher wage cost per unit
- those in which it has lower labour wage cost per unit
- the exceptions
Regression test for relationship between relative wage cost and relative export quantity
Regression test for relationship between relative prices and relative export quantity
Specification check
Vary relative wages for each good (instead of assuming that US / UK = 2)
Result
Generally confirmed, with some exceptions
Areas in which country had lower relative wage cost = areas in which country has higher relative export quantity–negative correlation
In terms of trade, category (1) was also where US had export surplus to UK, and category (2) was where UK had export surplus to US
When relative wages varied, hypothesis still stands
Negative correlation also found for relative prices and relative export quantities.
Weaknesses
Exports from the other country constitute only small amount of total consumption for each country, possibly because of tariffs
Excluded indirect labour–overestimates US comparative advantage in certain goods
Sample for second hypothesis was small
Discuss Stern’s tests of the Ricardian model.
Data
Extension of McDougall’s analysis
Data from US and UK manufacturing industries from MacDougall, plus more from 1950 and 1959
TYPE-III HYPOTHESIS
Hypothesis
Relative labour productivity is positively correlated with relative export performance
Methodology
Compute exports from US and UK to rest of the world, find ratio for each commodity for relative export performance
Specification checks
Labour productivity / labour costs / net costs (includes capital cost and profit per output unit)
Relative export performance / mutual exports
Results
Found that most industries showed positive correlation, although there were exceptions
Industries in which US productivity increased relative to UK were also industries in which US relative export performance improved
Labour costs were stronger predicator of export performance than net costs–> implies that labour productivity is key
Discuss McGilray and Anderson’s test of the Ricardian model. (from paper)
Data
Trade flows between UK and Ireland–data readily available because
- Ireland’s primary trading partner is the UK
- Irish economy is trade-dependent
- Irish economy has large primary commodity content
TYPE-II HYPOTHESIS
Hypothesis
Based on Ricardian model: differences in comparative advantage is due to differences in labour productivities only
Methodology
1. Calculated comparative productivity ratios:
fi(I) / fi(UK)
Rank all comparative producitivity ratios in increasing order
Ireland should tend to export those to the right, and import those to the left
2. Calculated propensity to export and propensity to import
Positive association between labour productivity ranking and propensity to export
The higher the producitivty ranking, the greater the propensity to export
Specification tests
Baseline: comparative productivity of direct labour inputs
Included: indirect labour inputs from non-traded goods (intermediate products) and indirect labour inputs from all sectors
Result
Cannot confirm Ricardian hypothesis
- Unable to clearly identify exporting and importing sectors
- Found negative correlation
Discuss McGilray and Simpson’s test of the Ricardian model. (textbook)
Data
Trade flows between UK and Ireland–data readily available because
- Ireland’s primary trading partner is the UK
- Irish economy is trade-dependent
- Irish economy has large primary commodity content (which we know is labour-intensive)
TYPE-III HYPOTHESIS
Hypothesis
Exports will have higher comparative labour productivities
Imports will have lower comparative productivities
Methodology
- Rank sectors by propensity to export (exports divided by GDP)
- Parallel ranking of sectors by propensity to import competing goods (imports divided by GDP plus imports)
- Rank comparative labour productivities (UK:US) for each sector
SHOULD see a positive correlation between (1) and (3), and a negative correlation between (2) and (3)
Specification tests
Baseline: comparative productivity of direct labour inputs
Included: indirect labour inputs from non-traded goods (intermediate products) and indirect labour inputs from all sectors
Result
No significant evidence of correlation, and most showed opposite signs!
Ricardian theory NOT CONFIRMED
What is Ricardo’s proposition?
A country exports the commodity in which it has a comparative labour productivity advantage.
What is Mill’s proposition? When does it fail?
The international price ratio lies in the range spanned by the pre-trade price ratios of the two trading nations.
This proposition fails when
- The two trading nations are identical in all respects (no trade occurs)
- The two trading nation are grossly different in size (international price follows the higher domestic price, whether Home or Foreign)
Decompose the gains from trade in the Ricardian model.
Gains from complete specialisation
Gains from lower world price (compared to autarky price)
IRL: immediate jump
What are the contributions of the Ricardian model?
- First trade model. Postulates gains from trade because of comparative advantage–still the strongest argument for trade today
- Simple–allows us to easily understand concept of comparative advantage, specifically as a result of differing factor productivities
- Distinguishes comparative advantage from absolute advantage
- Can be generalised to more than two countries, goods, and factors
What are the shortcomings of the Ricardian model?
- Predicts / recommends complete specialisation–risky!!
- Difficult to test predictions–in real life, we also have intra-industry trade. This means:
- Hard to classify goods as imports / exports
- Similar (instead of dissimilar) countries engage in trade
- No welfare considerations–efficiency over equity, but not everybody is better off
