Chapter 4 Trade Model Extensions and Applications

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Chapter 4 Trade Model Extensions and Applications

• Key words
• Business services ????
• Distribution of income ????
• Dynamic comparative advantage ??????
• Economies of scale ????
• Environmental regulation ????
• Factor-endowment theory ?????
• Industrial policy ????
• Interindustry specialization ??????
• interindustry trade ?????

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• Leontief paradox ??????
• Polluter-pays principle ???????
• Product life cycle theory ????????
• Specific-factors theory ??????
• Theory of overlapping demands ??????
• Transportation costs ????

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4.1 Factor-endowment theory

• Factor-endowment theory
• The factor endowments underlay a nations
  comparative advantage.
• Factor-endowment theory is also known as the
  Heckscher-Ohlin theory.

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• The factor-endowment theory states that
  comparative advantage is explained exclusively by
  differences in relative national supply
  conditions. In particular, theory highlights the
  role of nations resource endowments (such as
  labor and capital) as the key determinant of
  comparative advantage.

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4.1.1 Factor-price equalization

• Factor-price equalization
• With trade, the price of land tends to
  equalize in the two trading partners. So the
  conclution is that by redirecting demand away
  from the scarce factor and toward the abundant
  factor in each country, trade leads toward factor
  price equalization. In each country, the cheap
  factor becomes more expensive, and the expensive
  factor becomes cheaper.

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4.1.2 Trade the distribution of income

• Not only trade does affect a countrys total
  income level, but also it affects the internal
  distribution of income among the owners of
  resources.
• The increase in the returns to each countrys
  abundant factor comes at the expense of the
  scarce factors returns.

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• According to the factor-endowment theory,
  increased trade could worsen inequalities in
  wages even while increasing national income.

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4.2 Does trade make the poor even poorer?
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• College Advantage

Additional wages,in percent, earned by college
graduates compared with those who didnt attend
college
70
60
50
40
30
75
80
85
90
95
1973
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• The wage gap between skilled and unskilled
  workers widened in the United States between the
  1970s and 1990s.
• Is trade harming low-skilled workers?
• If so, is this an argument for protectionsim?
• The answer is
• The combination of trade, technology,
  education, immigration, and union weakness has
  held down wages for unskilled American workers.

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• Sources of Inequality
• Contribution of various factors to wage
  inequality in percent

Technological change
37.7
37.7
Unexplained
Trade
10.1
Stagnant Minimum wage
7.2
Decline of unions
4.4
2.9
Immigration
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• Trade does have some effect on U.S.wage
  stagnation, but not nearly as great an effect as
  technological change, most economists maintain
  that within-industry shifts in labor demand, away
  from less educated workers, are the most
  important factors behind the declining wages of
  the less educated.Such shifts appear to be the
  result of economy-wide technological and
  organizational changes in how work is performed.
• Even if the impact is small, trade indeed seems
  to have some adverse effect in aggravating wage
  inequality. In many ways, the effects of trade
  are similar to those of technological advance
  both increase national income but can worsen
  inequality.

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4.3 Are actual trade patterns explained by the
factor-endowment theory?

• In the United States capital was relatively
  abundant and labor was relatively scarce.
  According to the factor-endowment theory, the
  United States should export capital-intensive
  goods and its import-competing goods should be
  labor-intensive.
• Leontief paradox
• Leontief found that the capital/labor ratio
  for U.S. export industries was lower than that of
  its import-competing industries. Leontief
  concluded that exports were less
  capital-intensive than import-competing
  goods!These findings, which contradicted the
  predictions of the factor-endowment theory,
  became known as the Leontief paradox.

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• Early versions of the Heckscher-Ohlin model
  emphasized relative endowments of capital, labor,
  and natural resources as sources of comparative
  advantage. More recently, researchers have
  increasingly focused on the importance of worker
  skills in the creation of comparative advantage.
• Investments in skill, education, and training,
  which enhance a workers productivity, create
  human capital in much the same manner that
  investments in machinery create physical capital.

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4.4 Economies of scale and specialization

• Another explanation of trade patterns involves
  efficiencies of large-scale production, which
  reduce a firms per-unit costs.This is known as
  economies of scale.

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4.5 Theory of overlapping demands

• Theory of overlapping demands
• Linder hypothesis explain which types of
  nations will most likely trade with each other.
• Nations with similar per capita incomes will
  have overlapping demand structures and will
  likely consume similar types of manufactured
  goods. Wealthy(industrial) nations will likely
  trade with other wealthy nations, and poor
  (developing) nations will likely trade with other
  poor nations.

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4.6 Intraindustry trade

• Interindustry trade is bases on interindustry
  specialization Each nation specializes in a
  particular industry in which it enjoys a
  comparative advantage. Asn resources shift to the
  industry with a comparative advantage, certain
  other industris having comparative disadvantages
  contract. Resources thus move geographically to
  the industry where comparative costs are lowest.
  As a result of specialization, a nation
  experiences a growing dissimilarity between the
  products that it exports and the products that it
  imports.

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4.7 Product cycles

• Product life cycle theory
• This theory focuses on the role of
  technological innovation as a key determinant of
  trade patterns in manufactured products.
  According to this theory, many manufactured goods
  such as electronic products and office machinery
  undergo a predictable trade cycle. During this
  cycle, the home country initially is an exporter,
  then loses its competitive advantage VIS-A-VIS

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4.8 Dynamic comparative advantageIndustrial
policy

• A variety of government policies can be used to
  foster the development and revitalization of
  industries, RD subsidies, loan guarantees,
  low-interest-rate loans, and trade protection.
  Creating comparative advantage requires
  government to identify the winners and
  encourage resources to move into industries with
  the highest growth prospects.

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4.9 Boeing, Airbus, and Industrial Policy

• 4.9.1 Subsides to an infant enterprise
• 4.9.2 Launch-Aid Subsidies

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4.10 Environmental regulatory policies and
international competitiveness

• It should be noted, that most industrialized
  nations are greater polluters than
  less-industrialized nations. Developing nations
  contend that industrial nations, rather than
  undertaking radical domestic environmental policy
  changes that threaten their own economic growth,
  attempt to impose stringent environmental
  standards on developing nations without any
  assistance in paying for them lack of
  compensation lessens the opportunity for
  less-industrialized nations to grow.

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NAFTANorth American Free Trade Area
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4.11 Trade in business services

• The export advantage in many services, as
  revealed by existing patterns of trade in
  services, appear to lie with the developed
  countries. Empirical evidence suggests that many
  traded services tend to be intensive in the use
  of both technology and capital, whether human or
  physical. This seems to give the developed
  countries a competitive edge. The United States,
  for example, has often been characterized as
  having a comparative advantage in business
  services this advantage reflects the
  longstanding position of the United States as a
  net exporter of technology and know-how.

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4.12 Transportation costs

• Trade effects
• Compared with free trade in the absence of
  transportation costs, when transportation costs
  are included the high-cost importing country will
  produce more, consume less, and import less. The
  low-cost exporting country will produce less,
  consume more, and export less. Transportation
  costs, therefore, tend to reduce the volume of
  trade, the degree of specialization in production
  among the nations concerned, and thus the gains
  from trade.