Chapter 4 Comparative Advantage and Factor Endowments Copyright

Modern Trade Theory • Differences in factor endowments lead to differences in productivity •

Heckscher-Ohlin (HO) Trade Model • A country’s comparative advantage lies in production of goods

TABLE 4. 1 An Example of Factor Abundance Copyright © 2011 Pearson Addison-Wesley. All

Heckscher-Ohlin (HO) Trade Model • The U. S. is richly endowed with a wide

Gains from Trade in the HO Model • Ricardian model: constant set of tradeoffs

Trade and Income Distribution • The HO model: – Labor can be divided into

The Stolper-Samuelson Theorem • Assumptions: – Labor earns wages proportionate to its skill level

The Stolper-Samuelson Theorem • An increase in the price of a good raises the

The Stolper-Samuelson Theorem • Not all factors in the export industries will be better

The Stolper-Samuelson Theorem • Ultimately, the effects on income of an opening of trade

Specific Factors Model • The HO model assumes that factors are mobile • The

Specific Factors Model • Endowment of specific factor plays a more critical role in

TABLE 4. 2 A Specific Factors Model Copyright © 2011 Pearson Addison-Wesley. All rights

Case Study – Winners & Losers of NAFTA • Mexico: relatively abundant supplies of

Table 4. 3 Major Products in U. S. -Mexico Trade Copyright © 2011 Pearson

Table 4. 3 (continued) Major Products in U. S. Mexico Trade Copyright © 2011

Empirical Tests of the Theory of Comparative Advantage • Tests of theories based on

Extension of the HO Model: The Product Cycle • Evolution of manufactured goods and

FIGURE 4. 5 The Product Cycle in High-Income Countries Copyright © 2011 Pearson Addison-Wesley.

FIGURE 4. 6 The Product Cycle in Low-Income Countries Copyright © 2011 Pearson Addison-Wesley.

Table 4. 4 Top Ten Chinese Exports to the United States, 2008 Copyright ©

Foreign Trade versus Foreign Investment • Based on product cycle, firms prefer to invest

OLI Theory OLI theory (Ownership-Location. Internalization) – Firms investing abroad own an asset that

Off-shoring and Outsourcing • Off-shoring: Some or all of a firm’s activities move to

Table 4. 5 U. S. Multinational Corporations and Production Outside the United States Copyright

Off-Shoring by US Multinational Corp. • Productivity increases enable greater share of value-added output

Migration and Trade • Three primary factors: – Supply-push factors: forces inside a nation

The Impact of Trade on Wages and Jobs • Short-run – Reduce jobs in

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Modern Trade Theory • Differences in factor endowments lead to differences in productivity • Nations are endowed with different levels of inputs Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -2

Heckscher-Ohlin (HO) Trade Model • A country’s comparative advantage lies in production of goods that intensively use relatively abundant factors – Factor abundance: relative abundance of a factor, and the factor’s relative cost is less – Relatively scarce resources are more expensive Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -3

Heckscher-Ohlin (HO) Trade Model • The U. S. is richly endowed with a wide variety of factors: natural resources, skilled labor, and physical capital • U. S. will export agricultural goods, machinery, scientific and engineering goods Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -5

Gains from Trade in the HO Model • Ricardian model: constant set of tradeoffs (costs) – One homogeneous input: labor • The HO model: (1) multiple inputs—labor capital, land, etc. —and (2) variations in the quality of inputs • PPC under the HO model – As produce more of one good, opportunity costs increases Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -6

Trade and Income Distribution • The HO model: – Labor can be divided into categories of different skill levels – Other types of inputs can be included – Industries can require different mixes of various inputs • Systematic relationship between the factor endowments of a country and the winners and losers from trade Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -7

The Stolper-Samuelson Theorem • Assumptions: – Labor earns wages proportionate to its skill level – Owners of capital earn profits – Landowners earn rents – The amount of income earned per unit of input depends on both the demand (derived demand) for inputs and the supply of inputs • Price of exported good rises, price of imported good falls Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -8

The Stolper-Samuelson Theorem • An increase in the price of a good raises the income earned by factors that are used intensively in its production (exports) • A fall in the price of a good lowers the income of the factors used intensively in its production (imports) Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -9

The Stolper-Samuelson Theorem • Not all factors in the export industries will be better off, and not all factors used in import competing industries get hurt • Abundant factors will benefit, while scarce ones will be hurt • Magnification Effect: the change in output prices has a magnified effect on incomes. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -10

The Stolper-Samuelson Theorem • Ultimately, the effects on income of an opening of trade depends on the flexibility of the affected factors • More flexible the resources are to adjust, the less hurt they are. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -11

Specific Factors Model • The HO model assumes that factors are mobile • The Specific Factors model assumes: – (1) land capital are immobile and cannot migrate (specific factors) – (2) labor is fully mobile and can migrate from one sector to another (variable factor) Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -12

Specific Factors Model • Endowment of specific factor plays a more critical role in determining comparative advantage – When trade opens, incomes rise for the owners of the abundant specific factor – Incomes decrease for specific factor in shrinking industry – Effect on labor is indeterminant – Prices in exporting industry rise, prices in importing industry fall Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -13

Case Study – Winners & Losers of NAFTA • Mexico: relatively abundant supplies of unskilled and semiskilled labor • US & Canada: relatively abundant supply of capital and skilled labor • Intrafirm Trade: Manufactures part of good in US and ships to Mexico for remainder • Moving production between US and Mexico has gains and losses Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -15

Empirical Tests of the Theory of Comparative Advantage • Tests of theories based on factor endowments is difficult • Besides factor endowments, trade is affected by – – Technological differences Economies of scale Corporate structures Economic policies Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -18

Extension of the HO Model: The Product Cycle • Evolution of manufactured goods and technology • Early Stage: Likely in industrial countries – High income consumers – Scientific and engineering inputs – Capital • Middle Phase: Shifts to countries with low labor costs, standardized technology • Late Phase: More output shifted to developing countries, industrialized ones focus on new goods Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -19

Foreign Trade versus Foreign Investment • Based on product cycle, firms prefer to invest abroad than export • Substitute foreign investment foreign trade • Intrafirm Trade – Internationl trade between parent company and foreign-owned affiliate Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -23

OLI Theory OLI theory (Ownership-Location. Internalization) – Firms investing abroad own an asset that gives them a competitive advantage (Ownership) – Firms seek a production location that offers them advantages (Location) – Firms try to internally capture the advantages of foreign asset ownership (Internalization) Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -24

Off-shoring and Outsourcing • Off-shoring: Some or all of a firm’s activities move to a location outside the home country • Outsourcing: Reassignment of activities to another firm, either inside or outside the home country • Can use foreign affiliate • Technology makes it easier • Benefits from trading services should be the same as traded goods. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -25

Off-Shoring by US Multinational Corp. • Productivity increases enable greater share of value-added output with smaller share of employment • Motivation to off-shore is access to market and produce specialized products not to escape regulations or find low wages • Most off-shoring occurs in high income, high wage economies Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -27

Migration and Trade • Three primary factors: – Supply-push factors: forces inside a nation that cause people inside a nation to leave – Demand-pull factors: forces that pull a migrant to a particular country, or place within a country – Social networks: ability of migrants to congregate near family or community members to more easily assimilate into new locale Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -28

The Impact of Trade on Wages and Jobs • Short-run – Reduce jobs in an industry that is not competitive – Increase jobs in competitive industries • In medium- and long-run, trade has very little effect on the number of jobs – Jobs are dependent on: • Labor market policies • Incentives to work • Government macroeconomic policies Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 4 -29