- Solutions for Assignment #3 will be posted on Schoology in the next couple of days.
- Assignment #4 will be distributed at the end of this class. It is due next week.
- I will also distribute a set of sample questions today, for the final exam.
- Note that the final exam is on Wednesday, April 25th, from 6 to 9 PM.
- Because we need to make up the class we missed last week, we will be extending the class for 15 minutes each day, so we will end at 9:15 PM tonight and for the following weeks.
9. The Theory of the Determinants and Gains/Losses from Trade
Ricardian and Hecksher-Ohlin theories of comparative advantage, the potential gains and losses from trade, the sectoral effects of trade liberalization, the effects on wages and income distribution, the Stolper-Samuelson theorem, intra-industry trade, dynamic comparative advantage.
Readings:
Krugman, Obstfeld and Melitz, chapter 11.
Giorgio Barba Navaretti and Paolo Epifani, “Trade Policy Principles,” training module of the World Bank Course on “Trade Policy and WTO Accession for Economic Development: Application to Russia and the CIS,” Moscow, Russia, July 2004.
- In the last class, we started to discuss the question of what determines the competitiveness of domestic industries and, therefore, whether they become export or import industries.
The British economist
David Ricardo (1772-1823)
was the first to seriously
examine this issue.
- Ricardo argued that the most important factor in determining what products a country should export and import is based on the comparative or relative productivity of different firms or industries within the country.
- In other words, if the country can produce computer chips or software at a lower cost relative to producing steel or aluminum, then it should be exporting computer chips and software and importing steel and aluminum.
- This was called the theory of comparative advantage because it says that a country will export products in which it has a comparative –or relative– advantage in producing.
- Note that it does not say that countries will export products in which they are more productive relative to other countries.
- It says that countries will export those products in which they are more productive relative to other products that can be manufactured within the country.
- This is important because there is the fear that, if some countries are more productive than others in producing everything (they can produce computers more cheaply, or produce clothing more cheaply, or anything else), then they will export everything, and countries that are not as productive will end-up importing everything from the most productive countries.
- This type of viewpoint, which Ricardo argues is fallacious, leads policymakers in some countries to impose tariffs on imports from countries that are highly productive or have lower costs of production.
- But Ricardo argued that, for international trade, countries that are the most productive in everything compared to other countries, will not find it profitable to export everything but instead, they will profit by specializing in what they themselves do best, that is, those sectors within their economies in which they have the greatest productivity.
- The reason is because they can compete more effectively and profit more by focusing on producing those products that they themselves can produce at the lowest cost.
- If they focus instead on producing everything, there will be many firms that will be producing and exporting products that generate much lower profits than those of the sectors in which the economy is the most productive.
- A reallocation of resources from the relatively less productive to the relatively more competitive sectors would increase the economy’s overall productivity and wealth.
- Note that the concept of specializing in what you have a comparative or relative advantage in producing applies to many other fields and to life itself.
- It is best understood by using a life-example.
Even if, as a person, you are more talented than others in every field, the theory of comparative advantage says that you should focus your career in the field in which you are the most talented and relatively more productive (and can derive the most profit from).
For example, suppose you are very talented with your hands. No one else in your university and even in the country has the hand skills you have and so you could be a great medical surgeon. But you are also very fast at typing, among the best in your school and maybe top-twenty in the country.
Should you follow both careers: surgery and secretarial assistant? Maybe spend half a week as a surgeon and half a week as secretarial assistant?
- So, Ricardo argued that countries will export goods that they have a comparative advantage in producing, that is industries in which they can produce relatively more efficiently or at relatively low cost.
- But what Ricardo did not discuss that much was what are the factors that make a country most productive in some sectors of production relative to others.
- One could argue that the United States is more productive in producing high-tech products, such as Intel chips, compared to producing steel and aluminum.
- So, according to the theory of comparative advantage, the US should export high-tech products and import steel and aluminum from other countries.
- But what makes the US relatively more productive in producing computer chips relative to steel or aluminum?
Bertil Ohlin
(1879-1972)
Eli Hecksher
(1899-1979)
This is the issue that two Swedish economists,
Eli Hecksher and Bertil Ohlin, decided to examine.
- Hecksher and Ohlin theorized that the relative endowments of factors of production is what makes countries more productive in manufacturing certain products compared to others.
- These factors of production could be physical capital, unskilled labor, skilled labor, etc.
- So, the United States has abundant supplies of highly-skilled workers compared to less-skilled workers.
- Computer chips is an industry that requires the use of highly-skilled workers and so the abundance of such workers in the US makes the high tech computer and software industries relatively productive and competitive in the American economy.
- The US should therefore export these products.
- On the other hand, the United States does not have such an abundant supply of unskilled workers.
- Steel and Aluminum are industries that employ predominantly unskilled workers and wages for unskilled workers in the US are relatively high because the relative supply of these workers is not that much (the U.S. workforce is one of the most highly-educated ones in the world).
- So production of steel and aluminum in the U.S. is costly compared to other countries that do have an abundance of low-wage, unskilled workers, like Chin and India.
- The US should import aluminum and steel.
- So, there are two conclusions from our discussion so far.
- First of all, international trade can provide overall gains to an economy, if it specializes in its comparative advantage.
- But trade will have negative effects on some sectors of the economy (import sectors).
- The pro-trade argument is that the availability of world markets and global competition will make the domestic export markets grow more and make the domestic economy more competitive and efficient.
*
- But domestic sectors that are less productive and not very dynamic will not be able to compete with imports.
- Firms negatively affected by trade will see major bankruptcies and the disappearance of many businesses.
- This can be a painful adjustment for many in the economy, particularly the workers that are fired from the declining industries.
The evidence on the negative consequences of trade liberalization for some sectors within the economy is overwhelming.
To make trade policy changes more acceptable, proponents of trade liberalization suggest that trade adjustment policies must be introduced.
The idea is that the losers from trade be compensated by those that gain from trade, through programs that support newly unemployed workers with retraining programs or programs that offer temporary assistance in their relocation.
But these policies are not implemented most of the time.
- Since adjustments to trade can be more difficult and life-threatening in poor countries, some economists have argued that perhaps the WTO and high-income countries should engage in “fair trade.”
- The concept of “fair trade” is that since the poorest developing countries face the most difficult adjustments when opening to trade (and therefore implicitly benefit less from those adjustments), they should be provided with foreign aid intended to provide adjustment assistance to those who lose from trade.
*
- These readings discuss the issues:
- Joseph E. Stiglitz and Andrew Charlton, “Trade Can Be Good for Development,” in Stiglitz and Charlton, Fair Trade for All: How Trade Can Promote Development, Oxford University Press, New York, 2005, chapters 2,3 and 4 (I have substituted: Joseph E. Stiglitz and Andrew Charlton,, “Aid for Trade,” Research Report, The Commonwealth Secretariat, March 2006).
- See also: Bernard Hoekman, “Making the WTO More Supportive of Development,” Finance and Development, March 2005.
*
So, the theory suggests that international trade liberalization:
- Should raise overall economic growth, if the economy trades on the basis of comparative advantage,
- Could have very negative impacts on certain sectors of the economy.
So, what is the evidence on this?
Next, we discuss the empirical evidence on the connections between globalization, trade and growth.
INTERNATIONAL ECONOMICS
SECTION 10. THE EVIDENCE ON THE IMPACT OF INTERNATIONAL TRADE LIBERALIZATION
By
Francisco L. Rivera-Batiz
BAU International University
April 11, 2018
@ 2018 Francisco Rivera-Batiz, All Rights Reserved
*
10. The Evidence on the Impact of International Trade Liberalization
Evidence on the effects of international trade on income, economic growth, poverty and income distribution.
Readings:
Martin Ravallion, “Inequality and Globalization: A Review Essay, Society for the Study of Economic Inequality, Working Paper 435, April 2017.
Maurice Obstfeld, “Get on Track with Trade,” Finance & Development, December 2016, pp. 12-16.
Joseph Stiglitz, “Globalization and its New Discontents,” Project Syndicate, August 5, 2016.
- The negative effects of trade on specific sectors of the economy are well-known.
- Many studies have documented these changes.
The U.S, economy, in particular, has lost a
significant chunk of jobs in manufacturing
because of cheaper imports from other countries.
- For instance, a 2015 study by Maximiliano Dvorsky, Lorenzo Caliendo and Fernando Parro (published by the St. Louis Fed)examined the effects of “the large increase in imports from China between 2000 and 2007 and analyzed its effects on U.S. labor markets across states and industries. We found that increased Chinese competition reduced manufacturing employment by 0.6 percentage points (or about 1 million jobs) over 10 years.”
Of course, during the same time
period, the U.S. gained millions of
jobs in high-tech and other sectors.
- So, what evidence is there that trade has an overall, positive effect on an economy?
The classical study on the effects of trade on economic growth is:
Jeffrey Sachs and Andrew Warner, “Economic Reform and the Process of Global Integration,” Brookings Papers on Economic Activity, 1995.
They looked at countries that were open to international trade and those that were closed, according to the index of an open economy they had developed. The question was: did open countries grow faster?
Note that in their paper, Sachs and Warner examined whether countries that were open in the period of 1965 and 1990 were countries that grew faster, holding other things constant.
In another paper, economists Romain Wacziarg and Karen Horn did something different.
They recognized that most countries opened up their economies to trade during a short period of reforms.
To examine the impact of these trade liberalization reforms, they looked at the growth experience of individual countries before and after the reforms.
The following is what they find for the sample of countries they examined.
- So, the evidence tends to indicate that trade liberalization does tend to foster economic growth.
- But what about the point made by opponents of globalization that trade has led to greater poverty and worsening income distribution?
- What does economic theory predict is the impact of international trade on poverty and income distribution in developing countries?
- If, for instance, we look at the wages of skilled workers relative to the wages of unskilled workers, what does the theory say will happen when trade liberalization occurs: do the wages of skilled workers rise or decline relative to those of unskilled workers?
*
- Economic theory suggests that, for developing countries, which have a lot of unskilled labor, trade liberalization will lead to an increase in the demand for these workers and, therefore, the wages of unskilled workers will rise relative to those of skilled workers.
- Income distribution should improve as a result of trade. Poverty should decline!
*
This result is
called the
Stolper-Samuelson
theory, in honor of
the two economists
who studied
it, Wolfgang Stolper
and Paul Samuelson
*
- So, what is the empirical evidence on this issue?
- Does trade liberalization lead to lower poverty and inequality in developing countries?
*
- Trade liberalization has increased sharply since 1980.
- How has poverty changed?
*
Poverty Rates in the Developing World,
By region, 1981-2012
_______________________________________________
Region 1981 2012
_______________________________________________
East Asia and Pacific 80.6% 7.2%
Europe and Central Asia 1.9 2.1
Latin America and Caribbean 23.9 5.6
Middle East and North Africa 9.6 4.2*
South Asia 58.1 18.8
Sub-Saharan Africa 51.5 44.4
_______________________________________________
World Bank (2016). *= estimate for 2010
*
- The drop in world poverty since the 1980s coincides with the rise of globalization and appears to be consistent with a negative impact of increased trade on poverty.
- Furthermore, the two economies that have seen some of the sharpest increases in openness, China and India, are also the two economies where poverty has dropped the most.
- And in sub-Saharan Africa, the region which has been the slowest to open to trade (with 50% of countries closed to trade, at the present time, under the Sachs-Warner methodology) poverty did not decrease at all.
*
- But there are a number of caveats to this result.
- The most obvious one is that globalization is not the only thing that has happened in the world since 1980.
- Countries have experimented with different policies (some liberal, other neo-liberal).
*
- One may be attaching to trade what is really the outcome of something else.
- For instance, consider the case of China.
*
- China’s poverty has declined sharply from 88.3% in 1981 to 11.2% in 2010, just as the economy has become more open to trade.
- But in reality, a substantial part of the drop in poverty in China happened in the early 1980s, before trade was a big factor in the economy.
- Between 1981 and 1990 poverty declined from 88% to 67%.
- Why?
*
- Rural poverty declined sharply in China between 1980 and 1990.
- Why the drop in rural poverty?
*
- During the early and mid 1980s, China was already implementing a comprehensive land reform project that allowed greater diversity in the use of land, a move that led to sharp increases in agricultural productivity and output.
- There were also agricultural sector reforms that resulted in the growth of local agricultural markets, which also stimulated production and income in rural areas.
- Another issue to consider is that in contrast to the drop of poverty during the period of globalization, most of the estimates available suggest that the recent expansion of international trade in the world has been associated with a period of increased inequality in many countries.
*
The Increase of Within-Country Inequality, 1970-2000
USSR and Former Soviet Union
*
The Distribution of Income in China
1970 – 2000
*
The Increase of Within-Country Inequality, 1970-2000
Nigeria
*
- But proponents of globalization have several answers to this criticism.
- First of all, they argue that in some countries –such as in Latin America– the period of increased trade has been associated with lower inequality, not rising inequality.
- Second, they argue that the reason for the increased inequality that we observe since the early 1980s is due to another major change that occurred at that time, and that has very little to do with international trade.
- What happened in the early 1980s that led to increased inequality?
The best-selling IBM personal
computer was introduced
in 1981, with operating
software created by Bill Gates’
Microsoft. Steve Jobs’
Macintosh Apple personal
Computer was introduced
in 1984.
*
Labor economists have
researched this issue
and they find that the
introduction of computers
first and later the internet
have generated major changes
in technology in almost
every sector of the economy.
Frank Levy and Richard
Murnane, The New
Division of Labor: How
Computers are Changing
the Next Labor Market,
Princeton University Press,
2004.
*
- According to proponents of globalization, the most important reason for the increased inequality since 1980 is that the effects of trade itself (as examined by Stolper-Samuelson) have been swamped by the effects of technological change.
*
- The new technologies are intensive in the use of human capital.
- They require that workers have greater skills.
- And this has resulted in rising demand for skilled labor and higher wages for skilled workers relative to unskilled labor, which generates inequality.
*
- So, what is the conclusion?
- The article by Ravallion (2017) in your reading list provides an answer:
- “While there can be little doubt that trade openness…[has] had distributional impacts…the jury is still out…that globalization has been the main force jointly creating both features. There has been considerable variance across countries in both their growth rates and the changes in inequality, and trade openness does not seem to stand out as the major generalizable causative factor… Technological change…could well be a much stronger force than expanding trade. Policies have mattered to both growing poor economies and redressing inequality within countries. And these policies can coexist with considerable global integration. Globalization may well be getting too much credit, and being blamed for too much.”
INTERNATIONAL ECONOMICS
SECTION 11. NATURAL RESOURCE EXPORTS: CURSE OR BLESSING?
By
Francisco L. Rivera-Batiz
BAU International University
April 11, 2018
@ 2018 Francisco Rivera-Batiz, All Rights Reserved
*
Although our earlier discussion did establish that countries that have liberalized their trade and have become more trade-oriented tend to grow faster, there is a set of countries that have adopted open international trade policies and promoted exports, but have failed miserably in improving their standards of living.
Which countries are these?
*
Natural-resource
exporting countries!!!!
Most people feel that oil-exporting countries grow faster than countries that do not have natural resources. But the reality is very different.
The evidence shows that resource-rich countries on average do not grow faster than other countries.
*
In fact, if you do a simple correlation between natural resource exports and economic growth, you find that the relationship is negative!
*
In 1995, Sachs and Warner studied the issue empirically, following the empirical cross-country growth analysis we have examined before.
J. Sachs and A. Warner, “Natural Resource Abundance and Economic Growth,” NBER Working Paper, December 1995.
*
*
- Since economic growth depends on a wide array of different variables, one should examine the impact of natural resources, holding other things constant.
- This is what Sachs and Warner did, using the same type of linear regression statistical analysis we have talked about before.
- This is one of their statistical equations.
*
Natural Resources and the
Growth of Per Capita GDP, 1970-1989
_________________________________________________
Variable Estimated Coefficient (t statistic)
_________________________________________________
Constant 6.991 (4.1)
Sachs-Warner Openness Index 2.661 (4.8)
Investment Rate (1970-89) 10.318 (3.4)
Natural Resource Exports/GDP -5.019 (-2.9)
_________________________________________________
N=88, R-squared = 0.48
*
Growth of GDP Per-Capita and Natural Resource Exports
Source: Jeffrey Frankel, Resource Abundance: Pitfalls and Prescriptions,
Harvard University (2013).
*
The fact that most natural-resource-rich countries appear to be growing slower than other economies has led some to refer to the presence of a “Natural Resource Curse.”
*
What explains the negative empirical connection between exports of natural resources and growth?
*
1. Dutch Disease
The name of Dutch disease originally appeared in The Economist magazine.
It refers to the exploitation of natural gas in the Netherlands, which everybody expected would lead to a boom in that economy. Unfortunately, that did not happen.
*
Dutch disease is the tendency for the expansion of natural resource exports to cause a contraction of other sectors of the economy, therefore producing very little overall economic growth.
As oil production expands, for example, it absorbs capital and other resources from the rest of the economy, and other sectors (manufacturing, services, research and development, etc.) collapse.
*
2. A second challenge associated with natural resources: the presence of large rents connected to these natural resources leads to active rent-seeking, corruption and the deterioration of public sector governance.
This is the point made by:
Xavier Sala-i-Martin and Arvind Subramanian, “Addressing the Natural Resource Curse: An Illustration from Nigeria,” International Monetary Fund Working Paper, July 2003.
*
“Stunted institutional development –including corruption, weak governance, rent-seeking, plunder, etc.– is a problem intrinsic to most countries that own certain natural resources, such as oil or minerals.”
Sala-i-Martin and Subramanian (1993)
*
- A third problem with countries that specialize in exporting natural resources is that most technological change emerges from other, more dynamic export sectors of the economy, in manufacturing and in services.
- Countries that export natural resources tend to have contracting or stagnating industrial and service sectors and, therefore, their technological change and innovation rates are dismal.
*
It was economist
Paul Krugman
who asked what
were the export
sectors that generated
the most technical
change in an economy.
He won the Nobel prize
for this research.
*
Krugman started by recognizing that there is a major difference in the international trade of developing countries from that of high-income economies.
- For high-income countries, intra-industry trade dominates.
- For instance, the US exports various types of automobiles to the rest of the world and imports many other types of automobiles from Korea, the European Community, etc.
- These are exports and imports of products in the same industry.
Japan
Intra-Industry Trade:
Exports and Imports of Automobiles
United
States
Exports of Toyotas
Exports of Hondas
Imports of Fords
Imports of Chevrolets
- How can this type of trade be explained?
- It is not because of comparative advantage (they are the same products that are being exported and imported)
- In the 1980s and 1990s, economists Joseph Stiglitz, Avinash Dixit, Paul Krugman and others argued that much of the demand for products in the economy is connected to the fact that the modern consumer has strong preferences towards product variety.
- Different consumers will buy different products in the same industry (cars or cereal or cellphones) at more or less the same price.
But when consumers value product variety, producers have an incentive to innovate new products, to differentiate themselves from other producers, and capture part of the consumer market.
- This product differentiation and commerce in similar products becomes part of the trade strategy of most producers in high-income countries.
- They will seek to market their new products in other countries, to compete with (and take some of the market share away from) producers in the same industry in those countries.
That is why in high-income economies there is so much two-way or intra-industry trade, defined as exports and imports of products in the same industrial category.
But how do we measure intra-industry trade?
Consider the following index, called the Grubel-Lloyd (GL) index of intra-industry trade, in honor of the two economists who first constructed it (Herbert Grubel and Peter Lloyd).
│Xik – Mik│
GL Index = 1 – —————–
Xik + Mik
Where:
Xik are exports of a product i in industry k
Mik are imports of a product i in industry k
If Xik = Mik then there is a lot of intra-industry trade and the index=1.
But if Xik = 0 or Mik = 0 then there is no intra-industry trade and the index is equal to 0
The Grubel-Lloyd index is high for high-income economies and low for developing countries.
___________________________________
Country Grubel-Lloyd Index for
country’s intl. trade
___________________________________
Bangladesh 0.10
Chile 0.26
Germany 0.75
USA 0.75
France 0.84
UK 0.85
___________________________________
Grubel-Lloyd index, 1960 (blue) and 1998 (purple)
The growth of intra-industry trade in a country suggests that domestic producers are innovating and generating new goods and services that are being purchased and used by both domestic and foreign buyers.
By stimulating this type of innovation, trade liberalization can be a boost to technical change.
This technical change is then transmitted into a growth of GNP per-capita.
By discouraging the growth of this type of industry, countries that specialize in exporting natural resources short-circuit their long-run growth opportunities.
Which explains their dismal record in terms of intra-industry trade.