Econ452 Learning Unit 07
- 1. Learning Unit 7 Income Distribution and Labor Mobility ECON452 International Economics
- 2. Objectives 1. Explain why trade will generate both winners and losers in the short run. 2. Describe the reasons why trade is a politically contentious issue. 3. Predict how immigrations may affect an economy.
- 3. Income Distributional Effect of Trade • On the Ricardian model of trade, labor is only factor of production, so not only that all countries gain from trade, but also that every individuals is made better off as a result of international trade. • If trade is so good for the economy, why is there such opposition? • In reality, trade creates winners and losers in an economy – Income distribution effect of trade.
- 4. Reasons for income Distributional Effect • Two main reasons why international trade has strong effects on the distribution of income within a country: • Short-run effect: Resources cannot move immediately or costlessly from one industry to another. (Learning Unit 7). • Long-run effect: Industries differ in the factors of production they demand. (Learning Unit 9).
- 5. Relative Price and Distribution of Income • When a country engages in trade, a relative price of goods will change. • When a relative price changes, how will it affect the incomes of the following three groups? – Workers (mobile factor) – Owners of capital (immobile factor) in cloth sector – Owners of land (immobile factor) in food sector • Suppose that PC increases by 10%. Then, the wage would rise by less than 10%.
- 6. • An area under marginal revenue product curve is total revenue. • When additional dLC hours of labor is hired, it brings MRPC of revenue per hour. • Additional dLC hours of labor will bring MRPC x dLC of revenue (shaded area under MRPC curve) in total. Marginal revenue product, MRPC MRPC Marginal Revenue Product Curve and Total Revenue
- 7. Measuring Distribution of Income • Under an assumption of zero economic profits, total revenue must be paid to owners of factors used for production –labor and capital owners in cloth sector. • A rectangular area below the wage rate (w) is total wage payment to labor (wage rate x labor hours). – w1 x LC 1 = total wage payment to labor • Total revenue (TR) is an area below MRP curve. • A triangle area below MRP but above the wage rate is total payment to capital owners. – TR = Payment to Labor + Payment to Capital Owners MRPC Marginal revenue product, MRPC w1
- 8. Real Wage Rate and Real Income • Real wage rate: Nominal wage rate divided by price of output (w/P) – A proportional increase in prices and wage will keep a real wage rate constant. • Real Income: Nominal income divided by price of output – Real income measures how many goods a person can purchase with his/her nominal income. – Alternative, it can be computed as Real income = real wage rate x labor hours – A proportional increase in prices and wage (nominal income) will keep real income constant. – Factor owners will benefit when their real income increases, not nominal income.
- 9. Measuring Distribution of Real Income • Dividing the labor demand curve by output price gives MRPC /PC = MPLC x PC / PC = W/PC MPLC = W/PC • The vertical axis measures real wage rate. • An area below MPL curve measure total output. • A rectangular area below the wage rate (w) is total real wage payment to labor. • A triangle area below MPL but above the real wage rate is total real payment to capital owners.
- 10. Effect of Rise in Price on Owners of Capital When relative price of cloth (PC/PF) increases • the output of cloth (QC) rises, so as the labor input in cloth sector (LC). • The real wage rate (w/PC) decreases. • Real income of capital (immobile factor) owners increases, while real income of labor may increase or decrease.
- 11. Effect of Rise in Price on Landowners When relative price of cloth (PC/PF) increases, relative price of food (PF/PC) decreases, and • the output of food (QF) falls, so as the labor input in food sector (LF). • The real wage rate (w/PF) increases. • Real income of land (immobile factor) owners decreases, while real income of labor may increase or decrease.
- 12. Change in Relative Price and Distribution of Real Income When a relative price of good increases, a relative price of the other goo decrease. • Owners of immobile factors in production of the good whose relative price increase are definitely better off. • Owners of immobile factors in production of the other good whose relative price decreases are definitely worse off. • Mobile factor owners (labor) may or may not be better or worse off: – Depends on the relative importance of cloth and food in workers’ consumption.
- 13. Definitely Better Consumption Area • Under autarky a country produces and consumes cloth and food at Point 2 on PPF – A shaded rectangular area indicates a consumption combination which is definitely better than Point 2 because the country can consume more of one or both goods than Point 2.
- 14. Budget Constraint and Gains from Trade • Under trade the county produces QC 1 of cloth and QF 1 of food at Point 1 on PPF and is able to sell and buy goods at a relative price of PC/PF. – The country can choose any point along the budget constraint line by trading goods at PC/PF. – The budget constraint line is equivalent to the trade possibility line (TF line) on Ricardian model. – Choosing a point on the budget constraint line under shared rectangular area, it is possible for the country to consume more of both goods than it would have in the absence of trade.
- 15. Gains from Trade and Distribution of Income • The economy as a whole gains from trade. – It is able to afford amounts of cloth and food that the country is not able to produce itself because the budget constraint with trade lies above the production possibilities frontier. • There are winners and losers from trade – Because trade is beneficial only if a country can trade at a relative price different from the domestic relative price under autarky, this change in relative price causes distributional effects on incomes among factor owners. – Trade benefits the factor that is specific to the export sector of each country but hurts the factor that is specific to the import-competing sectors.
- 16. Politics of Trade and Income Distribution • Trade often produces losers as well as winners. – Optimal trade policy must weigh one group’s gain against another’s loss. • Because the country as a whole benefits from trade, it is possible to redistribute income so that everyone gains from trade. – Those who gain from trade could compensate those who lose and still be better off themselves. However, in practice, it is hard to implement redistribution. • Typically, those who gain from trade are a much less concentrated, informed, and organized group than those who lose. – Special interest groups who suffer from trade always have louder voice against trade in politics.
- 17. Trade and Unemployment • Trade shifts jobs from import-competing to export sector. – Process not instantaneous – some workers will be unemployed as they look for new jobs. – New jobs may require new skills, which are difficult for older unemployed workers to acquire. • How much unemployment can be traced back to trade? – From 2001 to 2010, only about 2% of involuntary displacements stemmed from import competition or plants moved overseas.
- 18. Unemployment and Import in the U.S. • There no evidence of a positive correlation between unemployment and imports (relative to U.S. GDP) for the U.S. • Unemployment is primarily a macroeconomic problem that rises during recessions – Frictional unemployment. Note: The highlighted years are recession years
- 19. U.S. Manufacturing Employment and Import from China • Some argue that the import competition from developing countries, especially from China, is at fault for declines in manufacturing jobs in the U.S. – They advocate closing off the U.S. from trade with China to save manufacturing jobs in the U.S. • Facts are – The manufacturing employment share has been steadily decreasing over the last half-century well before imports from China began to increase in 1990s. – But, U.S. manufacturing was still producing the same quantity of goods, but was using fewer and fewer workers (due to increase productivity). – Main source of manufacturing job loss in the U.S. is technological advancement; Machines replace workers’ jobs
- 20. Trade Adjustment Assistance Program • Labor with limited skill in import-competing sectors are immobile in sense that they cannot easily transfer their skills to other sectors and are often required to move geographically to get other jobs. • Governments usually provide a “safety net” of income support to cushion the losses to groups hurt by trade (or other changes). • U.S. Trade Adjustment Assistance program provides – Extended unemployment coverage to workers who are displaced by a plant closure due to import competition – Retraining programs often free from local community colleges.
- 21. International Factor Mobility • Movements in factors of production across boarders include – labor migration – the transfer of financial assets through international borrowing and lending – transactions of multinational corporations involving direct ownership of foreign firms • Like movements of goods and services (trade), movements of factors of production are politically sensitive and are often restricted.
- 22. International Labor Mobility – Model Setup • Why does labor migrate and what effects does labor migration cause? • Modify Specific Factors Model with following setups: – Workers migrate to wherever wages are highest (like movement from one sector to another). – Consider movement of labor across countries instead of across sectors (instead of two sectors in one country, one sector in two countries). – Two countries produce one non-traded good (food) using two factors of production: Land cannot move across countries (immobile factor) Labor can move across countries (mobile factor). – No trade of goods The model depicts labor mobility as substitute for flow of goods across countries.
- 23. International Labor Mobility - Diagram • Instead of two sectors, the labor demand in two countries (Home and Foreign) – MPL in Home and MPL* in Foreign • Total labor supply in two countries is measure along the horizontal axis. – A quantity of labor in Home is measured from O, and a quantity of labor in Foreign is measured from O*. • Before immigration at L1, large supply of labor in Home relative to Foreign leads to lower wage rate in Home than Foreign. – Labor supply is OL1 in Home and O*L1 in Foreign. – Real wage rate is wC in Home and wB in Foreign. wB wC
- 24. Effects of International Labor Mobility • Labor moves from Home to Foreign (L1 to L2) to seek for higher wage. – A number of immigrants from Foreign to Home is L1L2. • Wage rate increases in Home (from wC to wA) and decreases in Foreign (from wB to wA). – As labor supply decreases, MPL increases in Home. – As labor supply increases, MPL decreases in Foreign. – Eventually, wage rate equalizes across countries (at wA). • World production of goods increase by the area shaded (area below MPL is Total Product). – This gain from immigration is similar to gains from trade. wB wC wA
- 25. Distributional Effects of International Labor Mobility • Immigration of labor has distributional effects on factor owners. – Workers initially in Home benefit by earning higher real wages. – Workers in Foreign are hurt by decreasing real wages. – Owners of immobile factors (land and capital) in Foreign gain from the immigration of labor, which decreases real wages and increases output in Foreign. – Owners of immobile factors (land and capital) in Home are hurt by the immigration of labor, which increases real wages and decreases output in Home. • The U.S. faces inflows of immigrants from the south of boarder. – How will it affect labor, capital, and land owners in the U.S.? Who oppose the immigration?
- 26. Effects of Migration of Labor - Evidence • Up until the eve of World War I in 1913, wages rose faster in origin countries than in destination countries (except Canada). • Migration moved the world toward more equalized wages.
- 27. Effects of Migration of Labor - Evidence • Due to higher wages in Western Europe relative to its new EU partners in Eastern Europe, there have been substantial east-to-west migration flows. • A relative wage of manufacturing workers from the new 2004 member countries relative to Western Europe has been increasing as a result of migration of labor. – Before joining EU, Eastern European workers earned about 15% of Western European workers. – After joining EU, Eastern European workers earned about 25% of Western European workers. – Wage convergence between Eastern and Western European workers.
- 28. Immigration in the U.S. • In the early 20th century, share of immigrants in the U.S. increased dramatically. • Restrictions on immigration in the 1920s led to a sharp decline in the foreign-born population in the mid- 20th century. • New wave of immigration began around 1970. • As of 2014, 16.7% of the U.S. labor force is foreign-born.
- 29. Pattern of Immigration in the U.S. • Relative to native-born workers, foreign-born workers are concentrated in both the highest and lowest educational groups. • The largest increase in recent immigration occurred among workers with the lowest education levels, making less educated workers more abundant. – possibly reduced wages for native-born workers with low education levels while raising wages for the more educated – widening wage gap between less educated workers and highly educated workers.
- 30. Capital Mobility • Labor is not the only factor to move across boarders. Due to tighter restrictions on immigration, instead of labor immigrating to the U.S., capital is emigrating to developing countries where real wage rates are low (capital owners will earn more). • If capital is a mobile factor and labor is immobile factor, then how a movement of capital from the U.S. to foreign countries affects factor owners in the U.S.? – Owners of immobile factors (labor) in the U.S. are hurt by the outflow of capital which decrease real wages. • Foreign direct investment (FDI): a direct investment into production or business in a country by an individual or company of another country. – Off-shoring is a form of capital outflows from the U.S. to other countries.
- 31. Disclaimer Please do not copy, modify, or distribute this presentation without author’s consent. This presentation was created and owned by Dr. Ryoichi Sakano North Carolina A&T State University Disclaimer Please do not copy, modify, or distribute this presentation without author’s consent. This presentation was created and owned by Dr. Ryoichi Sakano North Carolina A&T State University