Chapter 10:

1. Chapter 10: Post-Heckscher-Ohlin and Intra-Industry Trade

2. Major implications of H-O theory Recall: H-O theory states that comparative advantage is based on two countries being abundant in different factors. Implication: Most trade should be between countries with different factor abundances.

3. Major implications of H-O theory Recall: H-O theory states that countries should specialize in, and export, goods that intensively use their abundant factor in production. Fact: Trade patterns are not so clear-cut.

4. Models besides H-O needed Chapter Introduction: Most Mexican exports �are not clothing, fruits and vegetables.� They are electrical machinery and equipment, vehicles, nuclear reactors, boilers and similar items. (p. 169) There is obviously a need for trade theory besides H-O

5. Chapter 10 - More Trade Theories These theories either examine trade flows that are counter to the H-O theory, or provide different explanations for trade flows.

6. Chapter 10 - More Trade Theories Theories are based on dynamic models of the economy OR different market structure, or demand patterns. No model of trade explains ALL international trade. Each model provides some understanding of underlying economic forces, and consequences to trade, and to economic choices.

7. Models/Theories/Thoughts on trade introduced in Chapter 10 Imitation Lag Hypothesis Product cycle theory Linder theory concept of intra-industry trade vs. inter-industry trade The Krugman model for monopolistic competition Reciprocal dumping and duopoly Gravity model Vertical specialization (intra-firm trade)

8. Note on trade theories in Chapter 10 Given that 7 different theories are presented here, none of them will be analyzed with the same depth of the H-O model Some will simply be described.

9. Note on trade theories in Chapter 10 I will try to follow the following format for each theory. Reason for trade under the model the �story of the model� the formal analysis, if one is available the implications of the theory in terms of trade patterns (if there are any) income changes within countries (if there are any)

10. 1. Imitation lag hypothesis Premise: trade is based on the development of new products Story: two countries I and II country I invents a new product at first only country I produces good, then, after some time, country II acquires the technology. at first only country I demands the good, then, after some time country II hears about it and wants to buy it

11. 1. Imitation lag hypothesis Formal elements of model: Imitation lag: the period of time between when the product is produced at home (country I) and when it is produced in country II Demand lag: the period of time between when the product is sold at home and when it is demanded by consumers in country II

12. 1. Imitation lag hypothesis Formal elements of model: The Net Lag: The difference between the imitation lag and demand lag provides the time period for which trade will determine the time when the product will be exported from country I to country II.

13. 1. Imitation lag hypothesis Formal elements of model: Example: New product introduced in country I. For 3 months, country II people do not demand it (no information, don�t know if it is good, etc�) After 3 months country II demands it. For 8 months from the start, country II can�t produce it. Net lag is 8 � 3 = 5 For 5 months the good is exported from country I to country II.

14. 1. Imitation lag hypothesis Implications of the model: New goods create opportunities for trade The shorter the demand lag the faster a good can be exported The longer the imitation lag, the longer a good can be exported. It is the net lag that determines the period of exports for a new good.

15. 2. The Product Cycle Theory The Premise: This theory addresses the pattern of trade based on the life cycle of products This theory is a dynamic theory of trade. Almost all other theories are static. It is built upon the imitation-lag hypothesis, but is more developed.

16. The Product Cycle The story: The new product stage a country introduces a new product into the market at first the product is sold at home only Maturing product stage then the product is exported as the world learns of the product and starts to demand it

17. Product Cycle The story (continued): The maturing product stage After the product is exported, its production expands substantially the product reaches a point where production can spread to other countries to have better access to markets to have better feedback from markets to reduce transportation and production costs

18. Product Cycle The maturing product stage (continued) The exports from the home country start to fall, but country is not yet an importer (personal aside: if I were writing this theory, it would be adolescent product until maximum exports reached)

19. Product Cycle � Standardized product stage Finally, so much production has moved out of the original country that this country is now a net importer of the product. Knowledge of the technology needed to produce the good is widespread, and the production is moved to where it is cheapest

20. The product cycle Formal analysis: Each stage can be described (as in story) and presented in a graph. new product stage � no trade maturing product stage � country I exports the new (and quickly aging) good standardized product stage � country I imports the (now older, standardized) good

22. Implications of model: Countries can be typified by which types of products they export maturing products or standardized products Countries with higher levels of technology and who undergo constant technological change can be expected to export newer products Countries with limited technology and innovation are expected to export standardized products

23. Implications of model: the highest returns to factors can be paid to producers in the new product stage ? Innovation pays Therefore, countries with a highly-paid workforce need to produce new goods and services the lowest returns to factors go to producers in the standardized product stage Countries with an abundance of lowly-paid labour can export standardized products ? standardized production can employ a lot of people

24. Implications of model: The implications of the imitation lag hypothesis still hold: We can still identify two distinct lags, and one that is derived from the difference in the two lags. Demand lag Imitation lag: Export monopoly duration: net lag length of imitation lag - demand lag = Net lag Export monopoly duration occurs during first part of maturing product stage

25. Recall: Demand lag where the product exists but there is no international demand for it - it is both produced and consumed at home only Imitation lag: the lag between product�s introduction at home and when it can be produced elsewhere. Export monopoly duration: net lag length of imitation lag - demand lag = net lag

26. More Implications:Dynamic Comparative Advantage Export source shifts through the life cycle of the product innovating country is the first exporter other developed countries then produce and export the good (note: this implies investment in production abroad) developing countries are exporters of standardized products

27. Dynamic Comparative Advantage Lesson for exporter: Don�t expect to maintain a comparative advantage in production forever! Dynamic comparative advantage can arise out of static comparative advantage (i.e. human capital used in R&D)

28. More Implications: Technology cycle In high-wage, (high skill labour abundant � imaginative?) countries there is cost incentive and market size needed for new product development and labour-saving technology Patents protect monopoly temporarily (expect rant on why patents should be targetted to provide the minimum protection required to encourage innovation)

29. More Implications: Technology cycle Labour abundant country doesn�t need labour-saving innovations less incentive to innovate in terms of labour saving products labour abundant country is more likely to imports the new product, not the technology as product reaches standard stage, labour abundant country will produce and export it human capital abundant country has newer technology