IBE303 Lecture 5

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IBE303 Lecture 5

  1. 1. Lecture 5<br />August 9th 2010<br />
  2. 2. The Basis for Trade: Factor Endowments and the Heckscher-Ohlin Model<br />
  3. 3. Heckscher-Ohlin In General<br />Heckscher, and his student Ohlin, worked in the early part of the 20th century.<br />Paul Samuelson refined their work after WWII.<br />Closer attention is paid in this model to each country’s resource endowment.<br />
  4. 4. Heckscher-Ohlin Model Assumptions<br />2 countries<br />2 commodities<br />2 factors <br />L - labor <br />K - capital<br />Perfect competition exists in all markets.<br />Each country’s endowment of factors is fixed.<br />Factors are mobile internally, but immobile internationally.<br />
  5. 5. H-O-S Assumptions (cont’d)<br />Each producer has a wide range of options as to how to produce X or Y<br />if K is cheap relative to labor, a relatively capital-intensive method will be adopted.<br />if K is expensive relative to labor, a relatively labor-intensive method will be adopted.<br />Each country has the same constant-return-to-scale (CRTS) technology.<br />Tastes and preferences are the same for both countries.<br />
  6. 6. Concepts and Terminology<br />The capital-labor ratio for good X is simply KX/LX, and for Y is KY/LY.<br />If KX/LX > KY/LY, production of good X is capital intensive relative to production of good Y.<br />For example, <br />the amount of capital per worker in the U.S. petroleum and coal industry is $468,000.<br />The similar figure for apparel products is $8,274.<br />Therefore, petroleum and coal is produced in a relatively capital-intensive manner.<br />
  7. 7. Concepts and Terminology<br />Also, production of Y must be relatively labor intensive (If KX/LX > KY/LY, then LY/KY > LX/KX).<br />That is, clothing is produced in a labor-intensive manner (as compared to petroleum and coal).<br />
  8. 8. Relative Factor Intensities, Selected Canadian Industries (2006), in C$<br />8-8<br />
  9. 9. Concepts and Terminology<br />Country A is said to be capital abundant relative to Country B if (K/L)A > (K/L)B.<br />For example, <br />if the U.S. has a capital stock of $4.8 trillion and a labor force of 153 million, then K/L is about $32,000. <br />K/L for Mexico works out to $328 billion/45 million = $7,282.<br />Therefore, <br />the U.S. is K- abundant relative to Mexico; <br />Mexico is relatively L-abundant.<br />
  10. 10. Relative Factor Endowments, Selected Countries (2007), in U.S. $<br />8-10<br />
  11. 11. Concepts and Terminology<br />To summarize:<br />goods are produced relatively K or L intensively.<br />countries are relatively K or L abundant.<br />
  12. 12. Concepts and Terminology<br />The factor price of labor (the wage) is “w”<br />The factor price of capital is “r”<br />If labor is relatively expensive, <br />w/r will be a relatively big number.<br />If labor is relatively cheap, <br />w/r will be a relatively small number.<br />
  13. 13. More on Factor Prices<br />What makes labor relatively expensive?<br />If it is relatively scarce.<br />What makes labor relatively cheap?<br />If it is relatively abundant.<br />So: If (K/L)A is a relatively big number (that is, capital is relatively abundant), <br />w/r will be a relatively big number, reflecting the relative scarcity of L and abundance of K.<br />
  14. 14. A Review of Trade in the Neoclassical Model<br />Suppose the U.S. is capital abundant relative to Mexico.<br />This, of course, means that Mexico is relatively labor abundant.<br />These differences affect the shape of each country’s PPF.<br />Suppose that cars are produced rel. K-intensively, and textiles labor intensively.<br />
  15. 15. Autarky in Mexico and the U.S.<br />The relative price of textiles in autarky is greater in the U.S. than in Mexico.<br />That is, the U.S.’s autarky price line is steeper than Mexico’s.<br />In symbols, (PTextile/PCar)US > (PTextile/PCar)Mex<br />This means that Mexico has the comparative advantage in textiles.<br />
  16. 16. Autarky in Mexico and the U.S.<br />This also means that the relative price of cars in autarky is lower in the U.S. than in Mexico.<br />That is, (PCar/PTextile)US > (PCar/PTextile)Mex<br />This means that the U.S. has the comparative advantage in cars.<br />
  17. 17. Trade in the H-O Model<br />U.S.<br />Mexico<br />Cars<br />Cars<br />e'<br />Y5<br />C'<br />Y3<br />E<br />e<br />Y1<br />Y4<br />c'<br />Y6<br />E'<br />Y2<br />X1<br />X2<br />Textiles<br />Textiles<br />X5<br />X6<br />X3<br />X4<br />
  18. 18. The Result<br />The relatively capital abundant country (U.S.) exports the relatively capital intensive good (cars).<br />The relatively labor abundant country (Mexico) exports the relatively labor intensive good (textiles).<br />
  19. 19. The Heckscher-Ohlin Theorem<br />A country will export the commodity that uses relatively intensively the factor that country has in relative abundance.<br />A country will import the commodity that uses relatively intensively the factor that is relatively scarce in that country.<br />
  20. 20. The Source of Comparative Advantage<br />So it is a country’s relative factor endowment that determines its comparative advantage.<br />This is why the H-O-S model is also called the factor proportions theory.<br />
  21. 21. Changes in Relative Commodity Prices : Review<br />As we learned before, <br />(PTextile/PCar)US falls as the U.S. moves to trade. That is, the international relative textile price is lower than the U.S.’s autarky price.<br />(PTextile/PCar)Mex rises as Mexico moves to trade. That is, the international relative textile price is higher than Mexico’s autarky price.<br />
  22. 22. Changes in Factor Prices<br />In autarky, the K-intensive product (cars) is less expensive to produce in the U.S. as compared to Mexico.<br />This is because K is relatively abundant in the U.S., which makes the price of capital relatively low.<br />As trade commences, r will rise since demand for capital will rise.<br />
  23. 23. Changes in Factor Prices<br />In autarky, the L-intensive product (textiles) is more expensive to produce in the U.S. as compared to Mexico.<br />This is because L is relatively scarce in the U.S., which makes the price of labor relatively high.<br />As trade commences, w will fall since demand for labor will fall.<br />
  24. 24. Commodity and Factor Prices In Trade: A Summary<br />In our example, (PTextile/PCar)US falls as trade commences.<br />(w/r)US also falls.<br />In Mexico, the opposite is happening:<br />(PTextile/PCar)Mex rises.<br />(w/r)Mex also rises.<br />Therefore relative commodity and factor prices move together as trade commences.<br />
  25. 25. The Relative Cost Curve<br />PT/PC<br />(PT/PC)US<br />(PT/PC)Int<br />Both relative commodity and <br />factor prices equalize in trade.<br />(PT/PC)Mex<br />(w/r)Mex<br />(w/r)US<br />w/r<br />(w/r)Int<br />8-25<br />
  26. 26. The Factor Price Equalization Theorem (FPE)<br />In equilibrium, with both countries facing the same relative product prices, relative costs will be equalized. This can only happen if relative factor prices are equalized between countries.<br />
  27. 27. H-O and the Distribution of Income<br />The H-O theorem, together with the FPE theorem, also tell us about how the incomes of different groups within a country change as trade starts.<br />This provides insight into the politics of free trade.<br />
  28. 28. The Stolper-Samuelson Theorem (S-S)<br />As trade commences, the owners of the relatively abundant factor will find their real incomes rising; the owners of the relatively scarce factor will find their real incomes falling.<br />
  29. 29. H-O and the Distribution of Income<br />According to the S-S theorem, if the U.S. is a relatively K-abundant country, who in America should favor free trade?<br />Who in America should favor protectionism?<br />
  30. 30. Theoretical Qualifications to H-O<br />Suppose we relax some of the many assumptions. Will the implications of the H-O-S model still be the same?<br />
  31. 31. Qualification #1: Demand Reversal<br />Suppose we let demand conditions differ.<br />Suppose domestic demand for the good that uses relatively intensively the relatively abundant factor is very strong in each country.<br />That is, suppose demand for cars is very strong in the U.S., and that demand for textiles is very strong in Mexico.<br />
  32. 32. Qualification #1: Demand Reversal<br />Such strong demand makes the autarky car price in the U.S. higher, and the textile price in Mexico higher.<br />In the extreme, demand reversal could occur: <br />(PCar/PTextile)US > (PCar/PTextile)Mex<br />(PTextile/PCar) US < (PTextile/PCar)Mex<br />
  33. 33. Bottom Line on Demand Reversals<br />If demand reversals occur, the H-O theorem no longer holds: the K-abundant country is exporting the L-intensive good, and the L-abundant country is exporting the K-intensive good.<br />
  34. 34. Qualification #2: Factor Intensity Reversal<br />Implicitly, we’ve assumed that if good X is K-intensive relative to good Y at one factor price ratio, it will be K-intensive at all factor prices.<br />A FIR is when a good is relatively K-intensive at one set of factor prices, but relatively labor intensive at another.<br />
  35. 35. Qualification #2: Factor Intensity Reversal<br />FIRs occur when capital and labor can be substituted more easily in the production of one good than another.<br />
  36. 36. Factor Intensity Reversal: Implications for Trade<br />Suppose France is K-abundant relative to Germany (that is (K/L)France > (K/L)Germany).<br />This means that (w/r) France > (w/r) Germany.<br />Suppose further that there is a FIR: in France, at (w/r ) France apples are produced relatively K-intensively but in Germany at (w/r ) Germany apples are produced in a relatively L-intensive way.<br />
  37. 37. Factor Intensity Reversal: Implications for Trade<br />If trade begins, according to the H-O theorem the relatively K-abundant country (France) will export the rel. K-intensive good (apples) and the rel. L-abundant country will export the rel. L-intensive good (also apples).<br />H-O theorem breaks down.<br />
  38. 38. Qualification #3: Transportation Costs<br />In the real world, it is costly to transport goods internationally.<br />How do the implications of our model change if we allow for transportation costs?<br />Consider the supply and demand curves for textiles in Mexico and the U.S.<br />
  39. 39. Adding Transportation Costs<br />Unless Mexico is the only seller in the world, transportation costs will be borne by both the consumer (the U.S.) and the seller (Mexico).<br />How does this look on the graph?<br />
  40. 40. Adding Transportation Costs<br />U.S.<br />Mexico<br />SText<br />PT<br />PT<br />SText<br />Exp.<br />PIntl<br />PIntl<br />t-costs<br />Imp.<br />DText<br />DText<br />q1<br />q2<br />q1<br />q2<br />QT<br />QT<br />8-40<br />
  41. 41. Adding Transportation Costs: the Bottom Line<br />In general, the H-O theorem will still hold.<br />The FPE theorem breaks down, since factor prices only equalize if the commodity prices do.<br />Therefore, in the presence of transportation costs, factor prices have a tendency to move towards each other, but we should not expect equalization.<br />
  42. 42. Relaxing Other Assumptions<br />One can relax many other assumptions and examine how the implications of the model change:<br />perfect competition<br />CRTS<br />identical production technologies<br />lack of policy obstacles<br />factors being perfectly transferable<br />
  43. 43. Post–Heckscher-Ohlin Theories of Trade and Intra-Industry Trade<br />
  44. 44. Posner’s Imitation Lag Hypothesis<br />In Posner’s model, there may be a delay in the diffusion of technology between countries.<br />If a new product is invented in country I, there are two sorts of lags that delay the production the good in country II: <br />imitation lag, and<br />demand lag.<br />During these lags the inventing country will export.<br />
  45. 45. The Product Cycle Model<br />How might comparative advantage change over time? H-O is a static model, and therefore offers little info on this.<br />The Product Cycle model (Vernon, 1966) follows a product from its invention through its “old age.”<br />How does it work?<br />
  46. 46. The Product Cycle Model: The New Product Phase <br />A new product is invented in the developed world.<br />Typically, the new product will be<br />capital-intensive and labor-saving.<br />aimed at high-income consumers.<br />All demand is located in the inventing country.<br />
  47. 47. The Product Cycle Model: The New Product Phase<br />Production is located in the inventing country.<br />Technological uncertainties make mass production unfeasible.<br />No trade occurs during this phase.<br />
  48. 48. The Product Cycle<br /> <br /> <br />Prodn, consn<br />Inventing country consumption<br /> <br />Inventing country production<br />time<br />t0<br />t1<br />New product phase<br />
  49. 49. The Product Cycle Model: The Maturing Product Phase<br />The product is increasingly standardized.<br />Consumers are increasingly aware of the product.<br />Mass production becomes possible, and economies of scale are realized.<br />Price steadily drops.<br />Demand in other developed countries picks up, so inventing country producers export more and more.<br />
  50. 50. The Product Cycle Model: The Maturing Product Phase<br />Later in the maturing product phase, other developed countries begin to produce the product.<br />Lower transportation costs may give these new entrants an edge in the emerging markets.<br />Increasingly, output in the inventing country is displaced.<br />
  51. 51. The Product Cycle<br /> <br /> <br />Prodn, consn<br />Inventing country consumption<br />exports<br />Inventing country production<br /> <br />time<br />t0<br />t1<br />t2<br />New product phase<br />Maturing product phase<br />
  52. 52. The Product Cycle Model: The Standardized Product Phase<br />Global demand has grown.<br />Production techniques are well-known and standard.<br />Competition becomes ever fiercer.<br />As a result, production shifts mainly to developing countries.<br />Product differentiation may occur, with the inventing country left producing only fancier versions.<br />The inventing country becomes a net importer.<br />
  53. 53. The Product Cycle<br /> <br /> <br />Prodn, consn<br />Inventing country consumption<br />imports<br />exports<br /> <br />Inventing country production<br />time<br />t0<br />t1<br />t2<br />New product phase<br />Maturing product phase<br />Standardized product phase<br />10-53<br />
  54. 54. The Product Cycle Theory<br />Vernon’s Product Cycle theory tells us that comparative advantage is fleeting: <br />we need to perpetually invent new products.<br />
  55. 55. Vertical Specialization<br />Different stages of production process may occur in different countries.<br />If different parts of the production process vary in terms of capital or labor intensity, the production process may be spread over multiple countries.<br />
  56. 56. Firm-Focused Theories<br />Stage theory: owners and managers learn over time; this implies exporting firms tend to be larger and run by more experienced managers.<br />Resource-exchange theory: firms internationalize because they cannot generate all resources domestically.<br />Network theory: networking can compensate for any lack of experience or expertise.<br />
  57. 57. The Linder Theory<br />In the H-O model, the pattern of trade is determined by relative resource endowments.<br />A model by Linder (1961) focuses mainly on the demand side.<br />Basic idea is that a country produces stuff to satisfy domestic demand; these goods will be likely exports (and imports, too).<br />
  58. 58. The Linder Theory: An Example<br />Suppose Country I’s income pattern is such that it produces goods A, B, C, D and E.<br />Let Country I have a relatively low per capita income level.<br />Suppose these goods are in ascending order of sophistication:<br />A and B are fairly simple.<br />C, D, and E are slightly more sophisticated.<br />
  59. 59. The Linder Theory: An Example<br />Suppose Country II has a higher level of per capita income.<br />It therefore produces goods C, D, and E (just like Country I), but also F and G.<br />F and G are even more sophisticated.<br />
  60. 60. The Linder Theory: An Example<br />Suppose Country III has an even higher level of per capita income.<br />It therefore produces good E (just like Country I), F and G (just like country II), but also H and J.<br />H and J are even more sophisticated.<br />Let’s look at a diagram of these countries:<br />
  61. 61. The Linder Theory: An Example<br />What products will I and <br />II trade? <br />I<br />A<br />B<br />C<br />D<br />E<br />C, D, and E.<br />II<br />G<br />C<br />D<br />E<br />F<br />III<br />G<br />E<br />F<br />H<br />J<br />10-61<br />
  62. 62. The Linder Theory: An Example<br />What products will II and <br />III trade? <br />I<br />A<br />B<br />C<br />D<br />E<br />E, F, and G.<br />II<br />G<br />C<br />D<br />E<br />F<br />III<br />G<br />E<br />F<br />H<br />J<br />10-62<br />
  63. 63. The Linder Theory: An Example<br />What products will I and <br />III trade? <br />I<br />A<br />B<br />C<br />D<br />E<br />E only.<br />II<br />G<br />C<br />D<br />E<br />F<br />III<br />G<br />E<br />F<br />H<br />J<br />10-63<br />
  64. 64. The Linder Theory<br />So trade will involve goods for which there is overlapping demand.<br />Implication: trade should be most intense between countries with similar levels of per capita income.<br />
  65. 65. The Linder Theory<br />This theory would explain two things that H-O cannot:<br />why most trade is between the industrialized countries, which all have (presumably) very similar resource endowments.<br />why a country might import and export the same product (intra-industry trade).<br />
  66. 66. The Linder Theory<br />The theory has been subjected to a barrage of tests.<br />Sailors, et al. (1973), Thursby and Thursby (1987), and McPherson, Redfearn and Tieslau (2000) and others found evidence to support the Linder theory.<br />Hoftyzer (1984), Kennedy and McHugh (1983) and others found evidence against the theory.<br />
  67. 67. The Krugman Model<br />Incorporates economies of scale and monopolistic competition.<br />Consider a graph:<br />The price of the good relative to the wage (P/W) is on the vertical axis.<br />Per capita consumption (c) is on the horizontal axis.<br />
  68. 68. The Krugman Model<br />Two functions are on the graph:<br />The PP curve slopes upward, since P/W increases as c increases.<br />The ZZ curve has a negative slope: as c increases, average cost decreases (due to economies of scale). To maintain the zero-profit condition in monopolistically competitive firms, price must be reduced.<br />
  69. 69. The Krugman Model<br />Point E is the initial <br />equilibrium, with the<br />firm maximizing its<br />profit, and earning <br />zero economic profit.<br />P/W<br />P<br />Z<br />E<br />(P/W)1<br />Z<br />P<br />c1<br />c<br />
  70. 70. The Krugman Model<br />Suppose this firm exists in country 1.<br />Let country 2 be identical to country 1 on both the demand and the supply sides of the economy.<br />Traditional trade theory posits that these countries would not trade.<br />However, because trade effectively increases the market size in each country, economies of scale are realized in the Krugman model.<br />Trade effectively shifts the ZZ curve to the left.<br />
  71. 71. The Krugman Model<br />Point E΄ is the new<br />equilibrium; per capita <br />consumption and P/W <br />have both decreased as <br />a result of trade.<br />P/W<br />P<br />Z<br />Z΄<br />E<br />(P/W)1<br />E΄<br />(P/W)2<br />Z<br />P<br />Z΄<br />c1<br />c2<br />c<br />
  72. 72. The Krugman Model: The Bottom Line<br />Although trade causes per capita consumption (c) to fall, total consumption of the firm’s output has risen.<br />P/W has decreased because of trade; this also means that its reciprocal (W/P) rises.<br />This suggests that trade causes the real wage of workers to rise.<br />Even owners of the relatively scarce factor see a rise in real wages, suggesting that the negative income distribution effects of trade may not occur.<br />
  73. 73. Other Trade Models<br />Reciprocal dumping model (Brander and Krugman, 1983)<br />Because of imperfect competition, intra-industry trade occurs in this model.<br />Welfare may increase due to increased competition, but may decrease due to waste involved with transporting identical products internationally; the overall welfare effect is unclear.<br />The gravity model<br />The focus is on explaining trade volume.<br />These models illuminate the underlying causes of trade.<br />
  74. 74. Intra-Industry Trade<br />Examples:<br />Japan imports and exports computers.<br />The Netherlands imports and exports beer.<br />The U.S. imports and exports broccoli.<br />H-O-S is useless in explaining this - there’s no way a country could export and import the same good.<br />
  75. 75. Intra-Industry Trade: Possible Explanations<br />Product differentiation<br />Transportation costs<br />Dynamic economies of scale<br />Degree of product aggegation<br />Differing national income distributions<br />Differing factor endowments and product variety<br />
  76. 76. How Common is Intra-Industry Trade?<br />A recent study by Brülhart attempts to measure IIT in several countries, using an index:<br />an index value of 0 implies no IIT is taking place.<br />an index value of 1 implies that a country’s exports in one product category exactly equal its imports.<br />
  77. 77. Intra-Industry Trade: Evidence from Brülhart (2009)<br />
  78. 78. Economic Growth and International Trade<br />
  79. 79. Introduction<br />How does economic growth in China affect other countries?<br />Has China’s growth come at the expense of other countries?<br />
  80. 80. The Trade Effects of Growth<br />As real income rises, <br />producers are affected: how should they alter production in response?<br />consumers are also affected: how should they spend the additional income?<br />
  81. 81. Trade Effects of Production Growth<br />If a country experiences growth its PPF will shift outwards.<br />The producers in that country will now have the chance to select a production point on the new PPF.<br />Suppose a country exports good X and imports good Y.<br />
  82. 82. Trade Effects of Production Growth<br />Y<br />III<br />IV<br />I<br />II<br />A<br />X<br />
  83. 83. Trade Effects of Production Growth<br />New production points in region II of the new PPF involve production of more of the export good (Y) and less of the import good (X).<br />This is ultra-protrade production growth.<br />This means the growth has a strong positive effect on the country’s desire to trade.<br />
  84. 84. Trade Effects of Production Growth<br />New production points in region I of the new PPF involve production of more of the both goods, but proportionately more of the export good (X).<br />This is protrade production growth.<br />This growth will have a positive effect on the country’s desire to trade.<br />
  85. 85. Trade Effects of Production Growth<br />New production points in region IV of the new PPF involve production of more of the import good (Y) and less of the export good (X).<br />This is ultra-antitrade production growth.<br />This means the growth has a strong negative effect on the country’s desire to trade.<br />
  86. 86. Trade Effects of Production Growth<br />New production points in region III of the new PPF involve production of more of the both goods, but proportionately more of the import good (Y).<br />This is antitrade production growth.<br />This growth will have a negative effect on the country’s desire to trade.<br />
  87. 87. Trade Effects of Consumption Growth<br />If a country experiences growth, the consumers in that country will now have the chance to select a new consumption point.<br />Let us continue to suppose a country exports good X and imports good Y.<br />To focus on consumption, we’ll look only at the consumption possibilities frontier (CPF).<br />
  88. 88. Trade Effects of Consumption Growth<br />III<br />IV<br />Y<br />I<br />II<br />B<br />CPF<br />X<br />
  89. 89. Trade Effects of Consumption Growth<br />New consumption points in region II of the new CPF involve consumption of more of the export good (Y) and less of the import good (X).<br />This is ultra-antitrade consumption effect.<br />This means the growth has a strong negative effect on the country’s desire to trade.<br />
  90. 90. Trade Effects of Consumption Growth<br />New consumption points in region I of the new CPF involve consumption of more of the both goods, but proportionately more of the export good (X).<br />This is antitrade consumption effect.<br />This growth will have a negative effect on the country’s desire to trade.<br />
  91. 91. Trade Effects of Consumption Growth<br />New consumption points in region IV of the new CPF involve consumption of more of the import good (Y) and less of the export good (X).<br />This is ultra-protrade consumption effect.<br />This means the growth has a strong positive effect on the country’s desire to trade.<br />
  92. 92. Trade Effects of Consumption Growth<br />New consumption points in region III of the new PPF involve consumption of more of the both goods, but proportionately more of the import good (Y).<br />This is a protrade consumption effect.<br />This growth will have a positive effect on the country’s desire to trade.<br />
  93. 93. Production and Consumption Effects Combined<br />To summarize the combined production and consumption effects of growth, we look at the income elasticity of demand for imports (YEM).<br />YEM is the percentage change in imports divided by the percentage change in national income.<br />
  94. 94. Production and Consumption Effects Combined<br />YEM = 1: neutral effect<br />0 < YEM < 1: antitrade effect<br />YEM < 0: ultra-antitrade effect<br />YEM > 1: protrade or ultra-protrade effect<br />
  95. 95. Sources of Growth<br />Technological change<br />Factor-neutral: results in same relative amounts of K and L are used.<br />Labor-saving: results in increases in relative amount of capital used.<br />Capital-saving: results in increases in relative amount of labor used.<br />
  96. 96. Technological Change: Commodity-neutral<br />Y<br />X<br />
  97. 97. Technological Change: Commodity-specific<br />Y<br />Y<br />X<br />X<br />11-97<br />
  98. 98. Sources of Growth<br />Factor Growth<br />Factor-neutral: K and L grow at the same rate.<br />Growth in K<br />Growth in L<br />
  99. 99. Factor Growth: Factor-neutral<br />Y<br />X<br />
  100. 100. Factor Growth: Factor-specific<br />Growth of factor <br />in which good Y <br />production is intensive.<br />Growth of factor <br />in which good X <br />production is intensive.<br />Y<br />Y<br />X<br />X<br />11-100<br />
  101. 101. Factor Growth and Trade: Small Country Case<br />Suppose good X is relatively labor-intensive, and Y is capital intensive.<br />Economic growth shifts the PPF disproportionately along the X-axis.<br />Since country is small international prices don’t change.<br />
  102. 102. Factor Growth and Trade<br />(Px/Py)intl<br />Y<br />Production of L-intensive <br />good rises; production of <br />K-intensive good falls.<br />Y1<br />E1<br />E2<br />Y2<br />X<br />X1<br />X2<br />
  103. 103. Factor Growth and Trade: the Rybczynski Theorem<br />Growth in one factor of production leads to <br />an absolute expansion of output of the product using that factor intensively and <br />an absolute contraction of output of the product using the other factor intensively.<br />
  104. 104. Factor Growth and Trade: the Rybczynski Theorem<br />If the abundant factor grows, there will be an ultra-protrade production effect. <br />If the scarce factor grows, there will be an ultra-antitrade production effect.<br />If the consumption effect is protrade, growth in abundant factor will increase trade overall; growth in scarce factor causes the opposite.<br />
  105. 105. Growth and Trade: Welfare Effects<br />Growth in K or technological improvements will generally increase welfare, since both increase real per capita income and allow a country to reach a higher indifference curve.<br />Growth in L may or may not increase welfare.<br />
  106. 106. Factor Growth and Trade: Large Country Case<br />Suppose a large country experiences growth in its abundant factor.<br />There will be an ulra-protrade production effect.<br />Assuming a neutral consumption effect, the growth will cause an increase in demand for imports and an increase in the supply of exports.<br />The increased willingness to trade leads to a deterioration in the country’s terms of trade.<br />
  107. 107. Large Country Case<br />(Px/Py)0<br />Y<br />Growth causes a decline in <br />the TOT to (Px/Py)1. Growth<br />increases welfare, but not as <br />much as in the small country <br />case. <br />C1<br />C2<br />C0<br />E2<br />E0<br />E1<br />(Px/Py)1<br />X<br />
  108. 108. Growth and Trade: Immiserizing Growth<br />It is possible that the deterioration in the terms of trade will be large enough that a country with growth finds itself on a lower indifference curve.<br />This phenomenon was dubbed “immiserizing growth” by Jagdish Bhagwati.<br />
  109. 109. Immiserizing Growth<br />(Px/Py)0<br />Growth causes a large <br />enough decline in that <br />welfare is reduced.<br />Y<br />C0<br />C1<br />C2<br />E2<br />(Px/Py)1<br />E0<br />E1<br />X<br />
  110. 110. Growth and the Terms of Trade: Developing Countries<br />Developing countries may experience declining terms of trade as they grow; this suggests a strategy of export product diversification.<br />Income elasticities of demand for minerals and food products tend to be low; those for manufactured goods tend to be higher.<br />Prices of non-petroleum primary products have generally declined over time.<br />
  111. 111. International Factor Movement<br />
  112. 112. Factors of Production: Capital <br />Types of capital foreign investment<br />Foreign Direct Investment (FDI) <br />Foreign Portfolio Investment (FPI)<br />FDI: Can involve individuals but the bulk is done by firms.<br />known as: <br />Multinational corporations (MNCs)<br />Multinational Enterprise (MNE)<br />Transnational Corporation (TNC)<br />Transnational Enterprise (TNE)<br />
  113. 113. Global FDI Flows<br />In 2007, the accumulated stock of global FDI was over $15 trillion.<br />This stock grows rapidly each year – 22% in 2007 alone.<br />
  114. 114. U.S. FDI Abroad by Industry, 2007<br />
  115. 115. U.S. FDI Abroad by Region or Country, 2007<br />
  116. 116. World’s Largest Corporations, 2008 (billions of $)<br />12-116<br />
  117. 117. Reasons for International Movement of Capital<br />To access growing markets.<br />To secure access to raw materials.<br />To avoid tariffs and NTBs.<br />To take advantage of low wages.<br />Defensive purposes to prevent loss of market share.<br />Risk diversification.<br />MNC efficiency over local suppliers.<br />
  118. 118. Capital Market Equilibrium<br />MPPKII<br />MPPKI<br />Initially, suppose Country I has 0k1<br />as its capital stock. This means Country II <br />will have 0'k1.<br />MPPKII<br />MPPKI<br />0<br />k1<br />0'<br />12-118<br />
  119. 119. Capital Market Equilibrium<br />MPPKII<br />MPPKI<br />The price of capital will be r1<br />in Country I and r1’ in Country II.<br />r1<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k1<br />0'<br />12-119<br />
  120. 120. Capital Market Equilibrium<br />MPPKII<br />MPPKI<br />Output in Country I<br />r1<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k1<br />0'<br />12-120<br />
  121. 121. Capital Market Equilibrium<br />MPPKII<br />MPPKI<br />Payment to Labor<br />Payment to Capital<br />r1<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k1<br />0'<br />12-121<br />
  122. 122. Capital Market Equilibrium<br />MPPKII<br />MPPKI<br />Output in Country II<br />r1<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k1<br />0'<br />12-122<br />
  123. 123. Capital Market Equilibrium<br />MPPKII<br />MPPKI<br />Payment to Labor<br />Payment to Capital<br />r1<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k1<br />0'<br />12-123<br />
  124. 124. Capital Market Equilibrium<br />If capital can flow freely across international <br />borders, k2k1 units of capital will flow from <br />II to I because r1 > r1’. Eventually, r will fall in I<br />and rise in II until r = r2 = r2’ in both countries.<br />MPPKII<br />MPPKI<br />r1<br />r2'<br />r2<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k2<br />K<br />k1<br />0'<br />12-124<br />
  125. 125. Capital Market Equilibrium<br />MPPKII<br />MPPKI<br />What happens to output in Country I? <br />It rises due to the capital inflow.<br />Increase in output<br />r1<br />r2'<br />r2<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k2<br />K<br />k1<br />0'<br />12-125<br />
  126. 126. Capital Market Equilibrium<br />MPPKII<br />MPPKI<br />What happens to output in Country II? <br />It falls because of the loss of capital.<br />r1<br />r2'<br />r2<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k2<br />K<br />k1<br />0'<br />12-126<br />
  127. 127. Capital Market Equilibrium<br />MPPKII<br />MPPKI<br />What happens to output in Country II? <br />It falls because of the loss of capital.<br />Output after capital outflow<br />Loss in output<br />r1<br />r2'<br />r2<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k2<br />K<br />k1<br />0'<br />12-127<br />
  128. 128. Capital Market Equilibrium<br />MPPKII<br />MPPKI<br />Overall, world output rises.<br />r1<br />r2'<br />r2<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k2<br />K<br />k1<br />0'<br />12-128<br />
  129. 129. Economic Effects of International Capital Flows On Incomes<br />Output rises in country I (the country to which the capital flows), BUT:<br />Returns fall for capitalists, since their rate of return decreases.<br />Returns rise for laborers.<br />Capitalists are hurt; labor benefits.<br />Therefore, per capita income rises in Country I.<br />
  130. 130. Economic Effects of Int’l Capital Flows On Incomes<br />MPPKII<br />MPPKI<br />Loss by capitalists in Country I<br />r1<br />r2'<br />r2<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k2<br />K<br />k1<br />0'<br />12-130<br />
  131. 131. Economic Effects of Int’l Capital Flows On Incomes<br />MPPKII<br />MPPKI<br />Gain by laborers in Country I<br />r1<br />r2'<br />r2<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k2<br />K<br />k1<br />0'<br />12-131<br />
  132. 132. Economic Effects of Int’l Capital Flows On Incomes<br />MPPKII<br />MPPKI<br />Net income gain in Country I<br />r1<br />r2'<br />r2<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k2<br />K<br />k1<br />0'<br />12-132<br />
  133. 133. Economic Effects of Int’l Capital Flows On Incomes<br />Output falls in country II (the country from which the capital flows), BUT:<br />Returns rise for capitalists, since their rate of return increases.<br />Returns for laborers fall.<br />Capitalists are better off; labor is worse off.<br />Because overall incomes rise, per capita income rises.<br />
  134. 134. Economic Effects of Int’l Capital Flows On Incomes<br />MPPKII<br />MPPKI<br />Income gain by capitalists in Country II<br />r1<br />r2'<br />r2<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k2<br />K<br />k1<br />0'<br />12-134<br />
  135. 135. Economic Effects of Int’l Capital Flows On Incomes<br />MPPKII<br />MPPKI<br />Lost labor income<br />r1<br />r2'<br />r2<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k2<br />K<br />k1<br />0'<br />12-135<br />
  136. 136. Economic Effects of Int’l Capital Flows On Incomes<br />MPPKII<br />MPPKI<br />Overall gain in income in Country II<br />r1<br />r2'<br />r2<br />r1'<br />MPPKII<br />MPPKI<br />0<br />k2<br />K<br />k1<br />0'<br />12-136<br />
  137. 137. International Capital Flows: A Summary<br />Both countries’ incomes rise as a result of capital flows.<br />World output rises.<br />Capitalists in inflow country (Country I) and Laborers in outflow country (Country II).<br />Capitalists in outflow country (Country II) and Laborers in inflow country (Country I) are better off.<br />
  138. 138. Potential Benefits of FDI to Host Country<br />Increased output<br />Increased wages<br />Increased employment<br />Increased exports<br />Increased tax revenues<br />Realization of economies of scale<br />Import of technical and managerial skills<br />Weakening power of domestic monopoly<br />
  139. 139. Potential Costs of FDI to Host Country<br />Adverse impact in the country’s commodity terms of trade<br />Transfer pricing<br />Decrease in domestic savings<br />Decrease in domestic investment<br />Instability in the balance of payments<br />Loss of control over domestic policy<br />
  140. 140. Potential Costs of FDI to Host Country (cont’d)<br />Increase in Unemployment<br />Establishment of Local Monopoly<br />Inadequate attention to the development of local education and skills <br />Loss of natural resources<br />
  141. 141. Why Migrate?<br />Simply put, migration occurs when the expected costs of migrating are less than the expected benefits.<br />
  142. 142. Economic Effects of Labor Migration<br />GDP in Country I is given by the <br />shaded area:<br />MPPLII<br />WII<br />MPPLI<br />WI<br />Income of capitalists<br />Income of laborers<br />wII<br />wII<br />wI<br />wI<br />MPPLII<br />MPPLI<br />0'<br />L2<br />0<br />12-142<br />
  143. 143. Economic Effects of Labor Migration<br />GDP in Country II is given by the <br />shaded area:<br />MPPLII<br />WII<br />MPPLI<br />WI<br />Income of capitalists<br />Income of laborers<br />wII<br />wII<br />wI<br />wI<br />MPPLI<br />MPPLII<br />0'<br />L2<br />0<br />12-143<br />
  144. 144. Economic Effects of Labor Migration<br />If migration is possible, 0L1 workers will work <br />in Country I and 0'L1 in Country II. The wage will be the same: Weq.<br />MPPLII<br />WII<br />MPPLI<br />WI<br />wII<br />wII<br />weq<br />weq<br />wI<br />wI<br />MPPLII<br />MPPLI<br />0'<br />L2<br />0<br />L1<br />12-144<br />
  145. 145. Economic Effects of Labor Migration<br />What happens to Country I? GDP falls<br />because of out-migration:<br />MPPLII<br />WII<br />MPPLI<br />WI<br />Lost GDP<br />wII<br />wII<br />weq<br />weq<br />wI<br />wI<br />MPPLII<br />MPPLI<br />0'<br />L2<br />0<br />L1<br />12-145<br />
  146. 146. Economic Effects of Labor Migration<br />GDP falls in country I (the country from which the migrants come), BUT:<br />Wages rise for remaining workers.<br />It can be shown that the decrease in the Country I labor force is greater than the decrease in GDP, so per capita income rises.<br />Capitalists are hurt; labor benefits.<br />
  147. 147. Economic Effects of Labor Migration<br />What happens to Country II? GDP rises<br />because of in-migration:<br />MPPLII<br />WII<br />MPPLI<br />WI<br />Increase in GDPII<br />wII<br />wII<br />weq<br />weq<br />wI<br />wI<br />MPPLI<br />MPPLII<br />0'<br />L2<br />0<br />12-147<br />
  148. 148. Economic Effects of Labor Migration<br />GDP rises in country II (the country to which migrants go), BUT:<br />Wages fall.<br />It can be shown that the increase in the Country II labor force is greater than the increase in GDP, so per capita income falls.<br />Labor is worse off; capitalists are better off.<br />
  149. 149. Economic Effects of Labor Migration<br />Country I’s loss in GDP is smaller than <br />Country II’s gain, so world GDP rises.<br />MPPLII<br />WII<br />MPPLI<br />WI<br />Increase in GDPII<br />wII<br />wII<br />weq<br />weq<br />wI<br />wI<br />MPPLI<br />MPPLII<br />0'<br />L2<br />0<br />12-149<br />
  150. 150. Economic Effects of Labor Migration<br />Country I’s loss in GDP is smaller than <br />Country II’s gain, so world GDP rises.<br />MPPLII<br />WII<br />MPPLI<br />WI<br />Decrease in GDPI<br />wII<br />wII<br />weq<br />weq<br />wI<br />wI<br />MPPLI<br />MPPLII<br />0'<br />L2<br />0<br />12-150<br />
  151. 151. Economic Effects of Labor Migration<br />Country I’s loss in GDP is smaller than <br />Country II’s gain, so world GDP rises.<br />MPPLII<br />WII<br />MPPLI<br />WI<br />Increase in Total GDP<br />wII<br />wII<br />weq<br />weq<br />wI<br />wI<br />MPPLI<br />MPPLII<br />0'<br />L2<br />0<br />12-151<br />
  152. 152. International Migration: Other Considerations<br />Migrants now in Country II may send remittances back to Country I<br />So I’s per capita income rises by even more, and<br />II’s per capita income falls by even more.<br />If the migrants are “guest workers” and they can be paid a lower wage, it may be possible for capitalists in Country II to be better off without domestic labor being worse off.<br />
  153. 153. International Migration: Other Considerations<br />If the immigrants are low-skill workers, the host country may experience rising social costs.<br />If the immigrants are high-skill workers, the host country may benefit, and the migrants’ home countries may suffer. This is called the “brain drain.”<br />

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