I. International Trade and development

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I. International Trade and development

• Raul Caruso
• Università Cattolica del Sacro Cuore di Milano
• raul.caruso_at_unicatt.it

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• Lets Start

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• The main question of this course is
• Does trade help economic development?
• How?

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World Trade and World Income
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World Trade and World Income
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World Trade and World Income
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World Trade and Income
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Trade and World Income
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The question is still

• Does Trade cause GDP growth?
• The answer seems to be YES

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Trade and Income (Frankel and Romer 1999)
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Frankel and Romer 1999

• Frankel and Romer (1999) find that
• There is a positive effect of trade on income-
  (economic factors). The levl of income is
  increasing in trade share
• Increased size of the countries raises income.
  (geography matters)

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Trade Share or Trade Openess Ratio

• Trade Openess Ratio
• The trade-to-GDP-ratio is the sum of exports and
  imports divided by GDP. This indicator measures a
  country's "openness" or "integration" in the
  world economy. It represents the combined weight
  of total trade in its economy, a measure of the
  degree of dependence of domestic producers on
  foreign markets and their trade orientation (for
  exports) and the degree of reliance of domestic
  demand on foreign supply of goods and services
  (for imports).
• Trade Openess Ratio

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For example consider these countries
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Trade and Income, One more timeHarrison (2006)
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However,.

• Even if cross-country studies point to a positive
  relationship between globalization and overall
  growth, such growth may lead to unequal gains
  across different levels of income. If the growth
  effects on average are small trade-induced growth
  could be accompanied by a decline in incomes of
  the poor.

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Trade and PovertyHarrison (2006)
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Finally

• Therefore it seems that
• There is an association between poverty reduction
  and trade.
• But aggregate studies sometimes are misleading

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Main points or main questions?

• According to Harrison (2006) the evidence
  suggests that the poor are more likely to share
  in the gains from globalization when there are
  complementary policies in place
• investments in human capital and infrastructure
• policies to promote credit and technical
  assistance to farmers
• policies to promote macroeconomic stability.
• trade and foreign investment reforms have
  produced benefits for the poor in exporting
  sectors and sectors that receive foreign
  investment.
• Financial crises are very costly to the poor.

Finally, evidence suggests that globalization
produces both winners and losers among the poor.
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To continue.

• Therefore,
• Trade and development exhibit a complex
  association
• Nowadays in 2010 in the aftermath of the global
  crises the picture could be completely different
• We have first to go back to the basic economic
  theories of trade

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Consider that USA is the largest country in the
world with over the 21 of world income 17 of
world imports and 10 of world exports
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• Basic Economics of Trade The Ricardian Model

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Comparative Advantage Ricardo (1817)

1. A country(region) has a comparative advantage in
   producing a good (say clothing) if the
   opportunity cost of producing that good in terms
   of other goods is lower in that country than it
   is in other countries.
2. Eventually this country specializes in the
   production of clothing.
3. It will export clothing.

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Assumptions of Ricardian World

1. There are 2 countries Home and Foreign
2. Consider only two goods cheese and wine
3. There is only one factor of production Labor
4. Labor Productivity are constant

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Some notations

• The Home economy can be described by the
  following relation (see Krugman)
• Where

denote Unit Labour Requirements. In other words,
they are coefficients capturing costs and
technology of production. In this simplest case
they denote how many hours are needed to produce
a unit of a good.
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More.

• Note also that the ratio

Can be defined as the opportunity cost of cheese
in terms of wine. That is how many units of wine
I have to give up in order to have 1 unit of
cheese
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For example..

• If

This means that in order to have 1 extra unit of
cheese I have to give up 1/2 units of wine. In
one hour of work a person is supposed to produce
1 unit of cheese or ½ unit of wine.
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Identifying Comparative Advantage

• To have CA we must have

(1)
That is, Home country has a comparative
advantage in Cheese.
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What about Prices?

• Assume prices depending upon (1) cost (2)
  demand and supply.
• In autarky the relative prices of goods equal
  their relative unit labour requirements

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What about Prices?

• Note that if

The Economy will specialize in the production of
cheese if the relative price of cheese exceeds
its opportunity cost
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Prices and CA

• In the presence of CA we have

In the presence of trade the relative price of
cheese must lie between the opportunity cost of
cheese in terms of wine in Home and the
opportunity cost of cheese in terms of wine in
Foreign
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Prices and CA

• Consider the case

Both Home and Foreign will produce cheese. There
will be no wine. The supply of cheese goes to
infinity.
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A numerical example of CA
Note Home has higher labor productivity in both
industries In H the opportunity cost of
producing cheese in terms of wine ½ In F the
opportunity cost of producing cheese in terms of
wine 2
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Production and Consumption in Autarky
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A numerical example of CA
Assume that in world equilibrium the relative
price is Pc/Pw1 Home will specialize in cheese
production. Home workers can earn more by
producing cheese
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Production and Consumption with Trade
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Production and Consumption with Trade

• Consumption and Production Possibilities are
  higher in the presence of trade
• Supply of both goods is larger

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A trick?

• Note that in the example above we have

That is, Home is more productive also in the
production of wine, because it needs only two
hours of work whilst Foreign country needs three
(see the table). This is a case of Absolute
Advantage Is it a Trick? NO. The CA theory
suggests that each country specializes in the
production of good in which it has the RELATIVELY
lower unit labor requirements
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Another Example
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Another example

• Foreign has CA in Ham
• Home has CA in Peppers
• Foreign does specialise in Ham
• Home does specialise in Peppers

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CA Theorys Legacy

• Productivity differences play a role in
  international trade
• Comparative Advantage rather than Absolute
  advantage matters
• Evidence confirms that countries tend to export
  goods in which they have relatively high
  productivity

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Measuring Comparative Advantage

• Belassa Index of Comparative Advantage
• where for every time period t considered i
  denotes a specific country, w indicates the world
  economy (i.e. the entire set of countries
  considered in the analysis), and j is a specific
  sector. b is, therefore, a sectoral relative
  export measure in terms of share of world
  exports. Since the numerator ranges from 0 (the
  country is not exporting products belonging to
  that particular sector) to 1 (the country is an
  international monopolist in such category of
  products), and the denominator which is the
  economic dimension of the country, in export
  terms also ranges from 0 to 1, then b ranges
  between 0 and ED.

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Some Elaborations
Source De Benedictis (2005)
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A very simple model to explain competitiveness

• Consider only one factor of production Labor.
• This assumption holds in the short-run
• The Unit labour cost is the key factor
• The ULC can help us for a prediction of CA
• Prices depend upon ULC

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Notations

• Consider
• Employement N
• Average HoursAH
• Production Y
• Labor Productivity LP
• Wage W
• Unit Labor Cost ULC
• Exchange Rate E

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A very simple model

• You have N, Y, AH, W and E Then, The total hours
  worked (TH) are simply
• THNAH
• and the Labor Productivity (LP) is
• LPY/TH

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• Then, consider wages. Note that differently from
  neoclassical predictions in many countries (ex.
  European contries) wages are sticky.
• The unit labour cost then is given by ULCW/LP
• (1) when wages go up ULC goes up as well (2)
  when LP goes up ULC goes down.

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Identifying CA

• Then, consider the relation (1) and use ULC. It
  becomes

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A very simple model

• To have a trend consider growth rates. Take
  Natural Logs of our variables. Then, we have

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Therefore

• Therefore in the short run we easily find that
  prices depend upon ULC as

Where K denotes a mark up which in the shot run
can be easily assumed to be constant especially
within industries. Then we write simply that
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International Competitiveness

• To be sold on the world market goods have to be
  converted into an international currency. (say
  the ).

Where E denotes the exchange rate between the
home country and the american dollar assumed to
be the international currency. Therefore P is
the international price of goods to be exported.
Namely a key factor for international
competitiveness
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• Taking natural logs we can easily compute the
  growth rate of ULC expressed in dollars. This is
  a good proxy for evaluating international
  competitiveness.

Namely, the growth rate of international price of
goods to be exported equals the sum of growth
rate of exchange rate and the growth rate of ULC.
That is, the international competitiveness
depends upon (i) rate of change of exchange rate
(ii) change of productivity.
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Labor Productivity and Unit labour costs
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Productivity in OECD countries (growth rates)
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EU-15
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USA
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(No Transcript)
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Sweden
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Poland