International Economics By Robert J. Carbaugh 10th Edition

1. International EconomicsBy Robert J. Carbaugh10th Edition Chapter 3: Sources of Comparative Advantage

2. Why relative price differentials? Factor endowment theory (Heckscher-Ohlin) • Comparative advantage is explained entirely by different national supply conditions, especially resource endowments • Nations export products that use inputs which are relatively abundant (cheap) at home, and import products which need inputs which are relatively scarce (expensive) at home Carbaugh, Chap. 3

3. Why relative price differentials? Factor endowment theory: assumptions • Nations all have the same tastes and preferences (same indifference curves) • They use factor inputs which are of uniform quality • They all use the same technology Carbaugh, Chap. 3

4. Factor endowment model Comparative advantage according to factor endowment theory Autarky equilibrium Carbaugh, Chap. 3

5. Factor endowment model Comparative advantage according to factor endowment theory Post-trade equilibrium Carbaugh, Chap. 3

6. Factor endowment model Factor endowment theory: implications • Factor price equalization • The shift within each nation towards use of cheaper factors, and away from expensive ones, leads to more equal factor prices (if factors are mobile) • Distribution of income • Trade changes domestic distribution of income as demand for different factors changes • Does it work in practice? • Global wage differences suggest other aspects are important: uneven ownership of human capital; technological differences among nations; trade barriers; transportation costs; etc. Carbaugh, Chap. 3

7. Distribution of income Does trade worsen inequality? • Trade theory suggests that countries with abundant skilled labor will import goods which are made with unskilled labor (reducing domestic demand for unskilled labor) • Equilibrium wage ratios for skilled/unskilled labor are affected by trade and technology change, immigration, and education & training • Evidence suggests that trade contributes relatively little to wage inequality, compared to technological change and other factors; better education and training are potential solutions Carbaugh, Chap. 3

8. Distribution of income Sources of the increase in the ratio of skilled to unskilled wages in the US 1973-93 (percent) A. Forces Causing Greater Inequality of Wages International trade 7 Lower transport and communication costs 3 Liberalization of trade barriers 3 Production sharing with other countries 1 Immigration 2 Stagnant minimum wage 5 Decline of labor unions 3 Skill-biased technological change 29 Unexplained 29 B. Forces Causing Greater Equality of Wages Increase in supply of skilled workers relative to unskilled workers – 40 C. Net Effect 18 Note: Percentages for unequalizing forces must be chained, not added, to equal total unequalizing effect. Similarly, “A” and “B” must be chained to calculate “C.” Source: William Cline, Trade and Income Distribution, Institute for International Economics, Washington, DC, 1997, p. 264. Carbaugh, Chap. 3

9. Factor endowments Factor endowments of countries & regions, as a percentage of the world total Source: Elaboration on W. R. Cline, Trade and Income Distribution (Washington, DC: Institute for International Economics,1997) pp. 183–185. Carbaugh, Chap. 3

10. Factor endowments US human capital relative to those of other nations Although education captures only one aspect of human capital, it is the easiest to measure. *Enrollment ratios may exceed 100 percent because some pupils are younger or older than the country’s standard age for a particular level of education. **Tertiary education includes all postsecondary schools such as technical schools, junior colleges, colleges, and universities. Source: World Bank, Human Development Report, Washington, DC, 2003. See also World Bank, World Development Report. Carbaugh, Chap. 3

11. Factor endowments Heckscher-Ohlin, skills, and comparative advantage Carbaugh, Chap. 3

12. Bringing theory closer to reality Economies of scale & specialization • Economies of scale provide incentives for specialization, since per unit costs go down as production increases • Trade provides a larger potential market for products, making higher production levels possible • But, in theory, countries will specialize in products with a large domestic market (the home market effect), raising questions about trade’s impact on small nations and rural areas Carbaugh, Chap. 3

13. Economies of scale Economies of scale as basis for trade Carbaugh, Chap. 3

14. Economies of scale Trade & specialization under decreasing costs Carbaugh, Chap. 3

15. Bringing theory closer to reality Other extensions of the theory • Overlapping demands • Intra-industry trade • Product cycles • Dynamic comparative advantage - industrial policy • Impact of regulatory policy on trade (environmental regulation, for example) Carbaugh, Chap. 3

16. Bringing theory closer to reality Trade & the environment • Environmental regulation can lead to a policy tradeoff • Increased costs can reduce comparative advantage of regulated industry • Public receives health and environmental benefits • Concern that polluting industries would move to poor countries with less regulation • But studies indicate that environmental rules have a small role in investment location decisions • Polluter-pays principle: incentive to find ways to reduce pollution at least cost Carbaugh, Chap. 3

17. Trade & the environment Trade effects of government regulation Carbaugh, Chap. 3

18. Transportation costs Free trade under increasing costs No transportation costs Carbaugh, Chap. 3

19. Transportation costs Free trade under increasing costs Transportation costs of $2000 per auto Carbaugh, Chap. 3

20. Bringing theory closer to reality Specific factor theory • Looks at the income distribution effects of trade in the short run, when some factor inputs are not mobile among sectors • Indicates that workers may be better or worse off, depending on preferences • Predicts that owners of factors used in export industries gain from trade, while owners of factors used in import-competing industries will lose from trade Carbaugh, Chap. 3

21. Bringing theory closer to reality Relative prices and the specific factor model Carbaugh, Chap. 3