Growth Effects on Production Consumption Trade and Social

Growth: Effects on Production, Consumption, Trade and Social Welfare The Microeconomics of International Trade ECN 230 Roberto J. Garcia School of Economics and Business, NMBU Session 7

Growth and trade implications Economic growth Causes of growth and types and effects Causes • Factor endowments increase • Technology or L, K productivity improvements Growth effects across sectors • Non-sector specific • Sector specific Growth effects on production • Neutral (affects all sectors proportionately the same) • Non-neutral (affects one sector more than another) Growth effects on consumption • Neutral (affects all sectors proportionately the same) • Non-neutral (affects one sector more than another) 1

Growth and trade implications Graphical analysis of growth Initial equilibrium • PPC 0: Production of A, M fully employing L, K • Equilibrium at [PA/PM]W: Q 0, C 0 Growth shifts PPC outward to PPC 1 Neutral economic growth – parallel shift of the PPC Sector-specific growth – a disproportional shift of PPC toward a sector affected by the change (e. g. , agriculture) 2

Growth and trade implications Neutral growth, small country South (ag exporter) Potential growth effects on production – capacity to ↑Q • 1: Neutral production effect - proportional ↑Q relative to Q 0 • 2: Pro-trade - to the right of Q 1 on PPC 1 is a disproportional ↑QA • 3: Anti-trade - to the left of Q 1 on PPC 1 is a disproportional ↑QM 1: An anti-trade effect on production implies less specialization and lesser reliance on trade Q 1 is a proportional ↑Q relative to Q 0 2: A pro-trade effect on production implies (1) increased specialization and (2) greater reliance on trade or trade dependence 3

Growth and trade implications Potential growth effects on consumption – ability to ↑C • 4: Neutral consumption effect – proportional ↑C relative to C 0 • 5: Pro-trade – SW tangency to left of C 1 is a disproportional ↑CM • 6: Anti-trade – SW tangency to right of C 1 is a disproportional ↑ CA 5: A pro-trade effect on consumption implies greater reliance on trade (dependence) C 1 is a proportional ↑C relative to C 0 6: An anti-trade effect on consumption implies less trade dependence because lower willingness to import 4

Growth and trade implications Potential trade and welfare effects • Neutral growth, production and consumption, small country case • Trade triangle: proportional ↑ size; trade as % of GDP remains the same • Welfare increases by same % of GDP 5

Growth and trade implications Large country case Real effect: • Regardless of the type of growth or cause of growth, it results in ↑ production capacity in the real sector • The real effect is positive for the economy TOT effect: • When the real effect (↑Q) is sufficiently large, it will affect relative prices, PA/PM, especially if ↑Q outpaces ↑C • If the growth is sector specific, then the real effect is more pronounced in that sector, e. g. , biotech improves agricultural productivity such that QA ↑ relative to QM. • If ↑QA → ↓PA relative to PM, then 1 unit of import of M costs more in terms of units of A exported. Three possible outcomes • Real effect > TOT effect • Real effect = TOT effect (case in not shown in this tutorial) • Real effect < TOT effect 7

Growth and trade implications Sector-specific growth, large country case South’s perspective: case when real effect > TOT effect • PPC shift towards agricultural production, ↑QA: [Q 0]A to [Q 1]A • Negative TOT effect s ↑QA → ↓PA relative to PM s [QA]T made to be same in both eqlbm to show that [QA]T gets less [QM]T The positive effect of growth (real effect) is larger than the negative TOT effect and welfare is improved. Sector-specific growth with a pro-trade effect on agricultural production 8

Growth and trade implications South’s perspective: case when real effect < TOT effect • PPC shift is skewed towards agricultural production s ↑QA is shown to be large in absolute terms [QA]0 to [QA]1 s QM assumed to be unchanged • TOT effect is negative: s ↓PA relative to PM s ↑ export of A gets less import of M The positive effect of growth (real effect) is smaller than the negative TOT effect and welfare is reduced, “immiserizing growth” The ↑Q A relative to QM → ↓ TOT (↓P A relative to PM) from South’s perspective Sector-specific growth with a pro-trade effect on production 9

Growth and trade implications Concluding comments General lessons from the results • Economic growth is the result of an increase in factors (labor from immigration or population growth, or an increase in capital stock/inflows) or technology that improves the use of existing labor and capital stocks. • Technology can affect sectors proportionally the same or have implications on a sector-specific basis (e. g. , a green revolution in agricultural production, or use of robots in manufacturing) • The effect of growth has a positive real effect: the economy can produce more (↑ production capacity) • The effect of growth, when large, can negatively affect relative prices, TOT, particularly when growth is sector specific. s Depending on demand, sector-specific growth in the agricultural sector could ↑QA relative to the world market and ↓ PA relative to PM, worsening the TOT for net agricultural exporters. s Depending on demand, sector-specific growth in the manufacturing sector could ↑QM relative to the world market and ↓ PM relative to PA, worsening the TOT for net manufacturing exporters. s Thus, the large country case of growth can produce three outcomes: where 10 the growth effect greater than, equal to, or less than the TOT effect,