Trade- Practice and Theory

• Show relationships

• Despite Theory and Ideologies that are suspicious of trade.

• Something’s going on, and perhaps surprisingly most trade is between wealthy nations. European Union Trade

8000000

7000000

6000000

5000000

United States China (excluding Hong Kong) 4000000 Japan All countries of the world

3000000

2000000

1000000

0 1994a00 1996a00 2001a00 2006a00 Shares of World Trade

European Union 17.3

United States 16.1

China 9.6

Japan 6.7

Canada 4.1

Hong Kong, China 3.6

Korea, Republic of 3.5

Mexico 2.8

Singapore 2.8

Taipei, Chinese 2.3

India 1.6

Malaysia 1.6

Switzerland 1.6

Saudi Arabia 1.5

Australia 1.4

Other Members 17.5

0 5 10 15 20 25 30 35

HECKSHUR-OHLIN TRADE THEORY

• A nation will the commodity whose production requires intensive use of relatively abundant and cheap factor and import the commodity that requires the intensive use of scarce or relatively expensive factors. • Until the prices or factor costs are equal. TRADE RELATIONSHIPS X $1000

ASSUMPTIONS BEHIND PURE THEORIES OF TRADE

• Costless Transactions

• Full Resource Employment

• Pareto distribution (side-payments to losers.)

• Similar Technology

• Constant Returns to Scale

• Similar tastes

• Costless Factor Movements (land labor .) HECKSHUR-OHLIN TRADE THEORY • Assumes Differential productivity of Labor

• Heckshur-Ohlin incorporates differential factor endowments and factor intensity in products.

• Factor endowments

• Workers or Relative productivity of Labor

• Capital

• Factor Intensity of Products

• more capital or labor or land intensive per unit to produce

• Portugal has more sunshine=grapes

• England more textile mills/ sheep HECKSHUR-OHLIN TRADE THEORY

• Prediction one:

• Countries will focus on products whose input factors are relatively abundant within each country.

• Factor abundance can be measured in terms of relative factor prices, not simply ratio of availability.

• Similar to opportunity costs

• Factor prices are subject to competitive pressures. Demand for labor, or capital.

• H-O FACTOR-PRICE EQUALIZATION

• Heckshur-Olin corollary

• will bring about equalizations in relative and absolute returns to homogenous factors across nations.

• Means factors, like wages will equalize for comparably productive workers.

• Also means returns to capital will tend to equalize across borders once the international markets are accessed.

• Creates race-to-the bottom arguments,

• Some room for competitive policies and externalizations of public bads. HECKSHUR-OHLIN TRADE THEORY

• Trade acts as a substitute for mobility of other factors (labor, capital). • Expectations of flows of other factors may also be demand driven. • labor to high-wage • capital to high interest or return countries. • Factor reversals • Leontief • Observed the US exported labor intensive goods, not capital as expected- despite being the most capital rich/ intensive country in the World. • maybe only two factor model (not natural resources) • Not inclusive of high human capital HECKSHUR-OHLIN TRADE THEORY

• Leontief paradox drives Empirical Challenges to H-O, Stolper- Samuelson • Increasing returns to scale • maybe only two factor model (not natural resources) • Not inclusive of high human capital/ heterogeneous labor • Consumption/ demand driven production • Role of transport costs • Transaction costs • exchange rate, contracts, information acquisition • Assymetrical/expensive Information • Path dependencies- Geographic eg. RELAXING ASSUMPTIONS OF PURE THEORY OF TRADE

• Acquired Comparative Advantage: Means Comparative advantage is not just “Given” by Factor Endowments

• Economies of Scale

• Similar technologies

• Regulatory, or enforcement advantage

• Institutional Advantage

• Imperfect Competition RELAXING ASSUMPTIONS: ACQUIRED COMPARATIVE ADVANTAGE

• Acquired Comparative Advantage • Economies of Scale • more efficient production for larger scale (capital intensive operations) • Explains trade between similarly endowed countries. Is a central idea of gains from trade. • Thought to be complementary to H-O and gains from trade. • However, achievement of competitive scale for value-added sectors leads to some policy prescriptions • Strategic Trade policies: Infant Industry Arguments • subsidies • Tariffs • NTB RELAXING ASSUMPTIONS: ACQUIRED COMPARATIVE ADVANTAGE

• Strategic Trade Policy

• Subsidy decision

• Yingli and Solarworld consider new solar technology and manufacturing

• Market will only support one new producer 100 billion With Sub Costs No Sub Costs Rewards market 50%100 50%100 SolarWorld 75 billion SolarWorld 75 billion billion billion 75 %50 100 %50 100 Yingli billion-25 Yingli 75 billion billion billion subsidy RELAXING ASSUMPTIONS: ACQUIRED COMPARATIVE ADVANTAGE AND INCREASING RETURNS

• Welfare loss to Tariffs or NTBs thought to be offset by public good of infant industry support

• ISI= Import substitution industrialization

• Import substitution industrialization also argued to create local economy of scale, and eventually knowledge to manufacture high value goods.

• Brazil and airplanes, automobiles

• Quotas

• Increasing Returns to Scale can create monopoly firms in single nation markets. DIFFERENT TECHNOLOGIES

• Different technologies can alter efficiency, or change factor intensity of production.

• Advances in technology provide monopoly-like profits to leading firms.

• Substitution of labor for capital and vis-versa

• Elasticity of substitution: How easily labor can substitute for capital

• The costs of production may vary based on worker productivity.

• Human capital- multiplies the relative endowment effect of labor. More productivity per cost. DIFFERENT TECHNOLOGIES

• Different technologies can alter efficiency, or change factor intensity of production.

• Advances in technology provide monopoly-like profits to leading firms.

• National Policies of Subsidy to technology intensive industries,

• or technology development behind trade barriers.

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