Trade Models & Asian Economic Growth

INTERNATIONAL TRADE MODELS
& ASIAN ECONOMIC GROWTH
CHIRANTAN CHATTERJEE

1

Key Notions in International Trade
1) Absolute Advantage
2) Comparative Advantage
3) Terms of Trade

2

Some Basics in International Trade
1) David Hume’s Balance of Trade 1758
2) Puzzle for class:

Over the past few decades, East Asian economies have increased
their share of world GDP. Similarly, Intra-Asian trade has also
increased as a share of world-trade. Why?

3

Inspired by Physics & Newton
Newton’s Model

4

Some Basics in International Trade
1) Tinbergen’s (1962) Gravity Model

2) Economists show that 1% increase in distance between 2

countries -> fall in 0.7-1% trade.
3) So distance does matter – One of the most Robust Economic

Relationships
4) The argument behind RTAs
5

But Should Distance Matter?
1) Proxy for Transport Costs.
2) Proxy for ‘Time Elapsed’.
3) Proxy for ‘Transaction Cost’.

6

Augmenting the Gravity Model
1) With Income per Capita

o Many estimate gravity equations with the log of per-capita
incomes (lnM=POP) of the exporting and importing
countries included as well as the log of aggregate incomes
(ln M).
1) Adjacency Considerations
o Examples of this phenomenon include India-Pakistan,
Tijuana–San Diego, and HongKong–Shenzhen
1) Languages & Colonial Links
o Two countries that speak the same language will trade more
than pairs that do not share a common language.
o Measures of Colonial Links & Similarity +vely correlated
with Trade.
7

Trade Policies & the Gravity Model
1) FTAs lead to tripling of trade between nations (Frankel &

Rose 2000)
2) Mixed results on Monetary Agreements

o Countries that share a common currency trade like US
& Panama three times more than expectation.
o But some other studies have found that the triplingeffect doesn’t pan out similarly with EURO in EU.
1) What about the effect of Import Tariffs or VERs?

8

The Ricardian Model
o The Ricardian model uses the concepts of opportunity
o

o

o
o

cost and comparative advantage.
The opportunity cost of producing something measures
the cost of not being able to produce something else with
the resources used.
Example of Comparative Advantage?
o A country has a comparative advantage in producing a
good if the opportunity cost of producing that good is
lower in the country than in other countries. (US in
computers & Bangladesh in textiles)
Project Socrates.
Revealed Comparative Advantage
o (Eij / Eit ) / ( Enj / Ent )
o 1 < (CA) ; >1 (RCA)
9

The Ricardian Model

Suppose initially that Bangladesh produces computers and
the U.S. produces textile, and that both countries want to
consume computers and textiles.
Can both countries be better off?
10

The Ricardian Model
o
o

o
o
o

o

Labor is the only factor of production.
Labor productivity varies across countries due to
differences in technology, but labor productivity in each
country is constant.
The supply of labor in each country is constant.
Two goods: wine and cheese.
Competition allows workers to be paid a “competitive”
wage equal to the value of what they produce, and allows
them to work in the industry that pays the highest wage.
Two countries: home and foreign.

11

The Ricardian Model


The production possibility frontier of the home economy is:

aLCQC + aLWQW ≤ L

Labor required for
each pound of
cheese produced



Total
pounds of
cheese
produced

Total amount of
labor resources

Labor required for
each gallon of
wine produced

Total gallons
of wine
produced

When does one have maximum cheese and maximum wine production?

12

Labor Productivity & the Ricardian Model

13


o
o
o
o

Home has comparative advantage in ____, foreign in _____?
aLC /aLW < a*LC /a*LW
Relative price of ___ to ___ higher in foreign?
Home will ship ___ and foreign14
will ship ____?


o
o
o
o

Home has comparative advantage in ____, foreign in _____?
aLC /aLW < a*LC /a*LW
Relative price of cheese to wine higher in foreign?
Home will ship cheese and foreign will ship wine?
15

Steady State Prices Guided by the Following Rules
If
oPC /PW < aLC /aLW < a*LC /a*LW
home or foreign

then no cheese production at

oPC /PW = aLC /aLW < a*LC /a*LW , then domestic are indifferent,
foreign produces wine.
oaLC /aLW < Pc /PW < a*LC /a*LW , then?
o aLC /aLW < a*LC /a*LW < PC /PW, & now?
16

Broadly, Trade Enhances Consumption Possibilities in the
Ricardian World

17

Ricardo Tested in China’s Emergence

o China's emergence as an export powerhouse.
o China's overall labor productivity in the mid-90s was still lower than some

American/European standards.
o But in some specific industries, they did have comparative advantage with
the disadvantage dissipating.
o In those industries, it was one of the largest producers and exporters.
o China's relative productivity in apparel was higher than rest of
manufacturing. It had 8 times the size of Germany's apparel industry.

18

But Trade Can Happen Not Just because Labor
Productivity Differs

19

Could Happen Because Of Differences in Resources
Endowments

20

Enter Heckscher-Ohlin Model

21

H-O: Broad Intuition from the Nobel Foundation

22

H-O: Broad Intuition from the Nobel Foundation

23

Notice the H-O set up
o 2 Countries having different relative abundance of factors
of production.
o Production processes use factors of production with
different relative intensity.
o One can classify these countries: home and foreign. Two
goods: cloth and food. Two factors of production: labor
and capital.
o The mix of labor and capital used varies across goods.
o The supply of labor and capital in each country is constant
and varies across countries.
o In the long run, both labor and capital can move across
sectors, equalizing their returns (wage and rental rate)
across sectors.
24

H-O Differs from the Ricardian World
o All agents gain from trade in the Ricardian world but is
that true?
o Why then some are anti-trade and some are pro-trade?
o Is a single-factor of production a realistic assumption?
o For that matter 2 factors of production?
o Ricardian world advocates ‘complete specialization’ –
but is that realistic?
o But H-O also extends the Ricardian notion of
‘comparative advantage’ but conditional on resource
endowments – we will shortly see how.

25

Samuelson on Comparative Advantage – A Detour
o A mathematician, Stan Ulam, once challenged Paul
Samuelson to name one proposition in the social sciences
that is both true and non-trivial.
o His reply was: ‘the theory of comparative advantage’.
o “That it is logically true need not be argued before a
mathematician; that is not trivial is attested by the
thousands of important and intelligent men (and
women) who have never been able to grasp the doctrine
for themselves or to believe it after it was explained to
them. ”
26

Building Blocks: 4 Key Ideas in the H-O Model

1) The Stolper Samuelson Theorem:
o A rise in the relative price of a good will lead to a rise in the
return to that factor which is used most intensively in the
production of the good, and conversely, to a fall in the return to
the other factor.

27


2) The Rybczynski theorem:
o When only one of two factors of production is increased there is
a relative increase in the production of the good using more of
that factor. This leads to a corresponding decline in that good's
relative price as well as a decline in the production of the good
that uses the other factor more intensively.

28


3) The Factor-Price Equalization Idea
o

The relative prices for two identical factors of production will
eventually

be

equalized

international trade.

29

across

countries

because

of

.

4)The Heckscher-Olin Theorem:
o

It states that a country will export goods that use its abundant
factors intensively, and import goods that use its scarce factors
intensively. In the two-factor case, it states: "A capitalabundant country will export the capital-intensive good, while
the labor-abundant country will export the labor-intensive
good."

30

Let’s go through the nitty-gritties of H-O: Set-Up Again

Source: Klaus Desmet Lectures

31

Production of Food


32

Prices & Uses of Inputs


33

Prices & Relative Uses of Inputs


34

The Lerner Diagram
o This is the lowest possible cost,
an UNIQUE same isocost,
tangent to the two isovalue
curves.
o Here :
• r*Kf + w*Lf = r*Kc +
w*Lc
• Slope = w/r.
• We should be able to find
for each Pf/Pc , w/r

35

Remember Stolper-Samuelson!

1) The Stolper Samuelson Theorem:
o A rise in the relative price of a good will lead to a rise in the
return to that factor which is used most intensively in the
production of the good, and conversely, to a fall in the return to
the other factor.

36

Understanding Stolper-Samuelson

o LHS panel indicates relationship between prices and w/r. How?
o RHS panel indicates given w/r, relative use of K/L.
o Pf/Pc
w/r
Kf/Lf & Kc/Lc

37

Allocation of FOPs: The Edgeworth Box Diagram
 Given Pf/Pc, we know

Kf/Lf and Kc/Lc.
 From Origin Of we draw

a line with slope of Kf/Lf
and from Oc with slope
Kc/Lc.
 Intersection

point is
point of allocation of Kf,
Lf, Kc, Lc.

 Can we end up outside

the box? How

38

Recap: Rybczynski Theorem

When only one of two factors of production is increased there is a
relative increase in the production of the good using more of that
factor. This leads to a corresponding decline in that good's
relative price as well as a decline in the production of the good
that uses the other factor more intensively.

39

Rybczynski Theorem in a Edgeworth Box

o And you can then take the new Kf/Lf and Kc/Lc to that

2-sided diagram to back out new Pf/Pc
40

Rybczynski Theorem through a PPF

41

But we have still not discussed H-O’s key idea

A country will export goods that use its abundant factors
intensively, and import goods that use its scarce factors
intensively. In the two-factor case, it states: "A capital-abundant
country will export the capital-intensive good, while the laborabundant country will export the labor-intensive good."

42

To understand H-O we need to understand World RS-RD

43

Remember our Set-Up Again


44

Remember our Set-Up Again


45

World RS-RD & Autarky

 What is an autarky?
 Examples of autarky in today’s world?
 Synonym for an autarkic economy?

46

H-O, World RS-RD & Free Trade

 Relative prices converge.
 Spain exports computers, Poland food: H-O QED.

47

Gains from Trade & It’s Political Economy








Spain can export some computers now!
Relative price of food falls in Spain – what about in Poland?
Spain’s real wage ____ and rental rate _____?
Poland’s real wage ____ and rental rate ____ ?
Who will be pro-trade/against-trade in Spain?
In Poland?
48

Gains from Trade & It’s Political Economy








Spain can export some computers now!
Relative price of food falls in Spain – in Poland it rises.
Spain’s real wage falls and rental rate rises.
Poland’s real wage rises and rental rate falls.
Workers in Spain protest.
Capital owners in Poland protest.
49

What have we still not covered in H-O?


50

4th Tenet in H-O : Factor Price Equalization

The Factor-Price Equalization Idea
o

The relative prices for two identical factors of
production will eventually be equalized across
countries because of international trade.


51

FPE explained in a slide


52

o Since:
o With Free Trade:

o Therefore:
o Or
o Similarly we can show that that the rental rate r also converges.

53

o Since:
o With Free Trade:

o Therefore:
o Or

54

o Since:
o With Free Trade:

o Therefore:
o Or

55

o Since:
o With Free Trade:

o Therefore:
o Or

56

o Since:
o With Free Trade:

o Therefore:
o Or

57

When can FPE not apply?

o What if there are strategic barriers to trade?
o Could result in incomplete price equalization.
o Or if technology changes – Remember the Trade Contest!
o + Do countries produce both goods always?

58

The Leontief Paradox
o Leontief's paradox in economics is that the country with the

world's highest capital-per worker has a lower capital/labor ratio
in exports than in imports. This econometric finding was the
result of Leontief's attempt to test the Heckscher–Ohlin theory
empirically.
o In 1954, Leontief found that the United States—the most
capital-abundant country in the world—exported laborintensive commodities and imported capital-intensive
commodities, in contradiction with Heckscher–Ohlin theory.
o Stern & Maskus (1981) later find that the answer lies by

factoring in a 3rd factor of production.
o Guess which?
o Factoring in

Natural Resources makes the Leontief Paradox

go away – some other day.
62

H-O & it’s empirical relevance in Asia

Source: Bowen et.al AER 1987
63

H-O & it’s empirical relevance in Asia
 The authors calculated the ratio

of each country's endowment of
each factor to the world supply
of that factor.
 They then compared this ratio

with the country's share of world
income.
 If

FPE is correct, countries
would always export factors, for
which the factor share > income
share.

 But for 2/3rd of the FOPs trade

ran in the predicted direction less
than 70% of time.
Source: Bowen et.al AER 1987
64

H-O Effect in Bangladesh & German Exports to US

A country will export goods that use its abundant factors
intensively, and import goods that use its scarce factors intensively.
In the two-factor case, it states: "A capital-abundant country will
export the capital-intensive good, while the labor-abundant country
will export the labor-intensive good."
Source: Romalis (2004)

66

Rybczynski Effect in the 4 Tigers

When only one of two factors of production is increased there is a relative increase
in the production of the good using more of that factor. This leads to a
corresponding decline in that good's relative price as well as a decline in the
production of the good that uses the other factor more intensively.
Source: Romalis (2004)

67

Changing Patterns in Comparative Advantage

 In

1960
4
Tigers
specialized in low-skilled
intensity goods & so was
it in Japan.

 By 1998, the situation was

starting to change in both.
 The role of public policy

68

Source: Krugman et.al (2011)

What did we learn today?
1) Trades induces gains.
2) The

principle behind why so, lies in understanding
‘comparative advantage’ & its link to resource endowments.

3) The gravity model is one of the most robust relationships in

economics.
4) Which is why Asia’s intra-regional trade is very high.
5) H-O model has 4 predictions

69

 The Stolper Samuelson Theorem:
A rise in the relative price of a good will lead to a rise in the return to that
factor which is used most intensively in the production of the good, and
conversely, to a fall in the return to the other factor.
 The Rybczynski theorem:
When only one of two factors of production is increased there is a relative
increase in the production of the good using more of that factor. This leads to
a corresponding decline in that good's relative price as well as a decline in
the production of the good that uses the other factor more intensively.
 The Factor-Price Equalization Idea
Factor Prices Equalize in the long run due to trade.
 The Heckscher-Olin Theorem
Countries exports goods conditional on its resource abundance. Capitalintensive countries will export capital goods (US-computers) and laborabundant country exports the labor-intensive goods (Bangladesh–textiles).
70

 The Leontief Paradox
 H-O has mixed evidence in Asia. Japan is an exception too
 4-Tigers changes the terms-of-trade over time.
 Next Class: Strategic Trade Policies & Protectionism &

Globalization of the Value Chain & Implications for Trade.

71

Trade Models & Asian Economic Growth

More Related Content

What's hot (20)

Similar to Trade Models & Asian Economic Growth (20)

More from Chirantan Chatterjee (20)

Recently uploaded (20)

Trade Models & Asian Economic Growth

Editor's Notes