International Econs Notes 2

Prof Augustine H H Tan
Sem I 2014-5
Comparative Advantage
Factor Endowments
y Factor-endowment theory
y Heckscher-Ohlin theory
y Immediate basis for trade: difference between
pre-trade relative product prices of trading

nations
y Prices depend on the production possibilities
curves and tastes and preferences (demand
conditions) in the trading countries
y Production possibilities curves depend on
technology and resource endowments
Sources off Comparative

S
C
ti
Advantage
AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed
Sem I 2014-5
Factor Endowments
y Ultimate determinants of comparative
y Resource-endowment ratio
advantage
y Technology
y Resource endowments
y Demand
y Assumption: technology and demand are
approximately the same between countries
AT-Int Econ 103A; Text: R. Carbaugh, Int

Econ, 14th ed
Sem I 2014-5
Factor Endowments
Sem I 2014-5
y Determines comparative advantage

y Export the product that uses a large amount of
its relatively
y abundant resource
y Import the product which in production uses the
relatively scarce resource
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TABLE 3.1
Factor Endowments
Producing aircraft and textiles: factor endowments in the

United States and China
y Effect of resource endowments on comparative
advantage
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TABLE 3.2
Factor Endowments
Capital stock per worker of selected countries, 1997*
y Factor-endowment theory, U.S.-China trade

y United States
y Relatively abundant: human capital (skills),
scientific talent, and engineering talent are

relatively abundant
y Relatively scarce: unskilled labor is relatively
scarce
y China
y Relatively rich: unskilled labor
y Relatively scarce: scientific and engineering
talent
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Econ, 14th ed
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TABLE 3.3
Factor Endowments
U.S.-China trade: top ten products, 2007 (thousands of

dollars)
y Factor-endowment theory, U.S.-China trade

y United States exports to China
y Goods embodying relatively large amounts of
skilled labor and technology

y Aircraft, software, pharmaceuticals, and hight h components
tech
t off electrical
l t i l machinery
hi
and
d
equipment
y China exports to the United States
y Goods for which a relatively large amount of
unskilled labor is used
y Apparel, footwear, toys, and the final assembly
of electronic machinery and equipment
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FIGURE 3.2 The factor-price equalization theory (b)
Factor Endowments
y Factor-Price Equalization
y Redirect demand away from the scarce resource
y Toward the abundant resource in each nation
y Trade leads to factor-price equalization
y The cheap resource becomes relatively more
expensive
y The expensive resource becomes relatively less
expensive
By forcing product prices into equality, international trade also tends to force
factor prices into equality across countries.
y Until price equalization occurs
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Econ, 14th ed
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TABLE 3.4 Indexes of hourly compensation, manufacturing workers,

2006 (U.S.=100)
Factor Endowments
y Factor-Price Equalization
y Real world no full factor-price equalization
y Uneven ownership of human capital
y
Education, training, skill, and the like
y Not all countries use the same technology
New and better technology replaces older

technologies faster in developed countries
y Transportation costs and trade barriers
y Reduce the volume of trade
y
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14
Globalization drives changes for U.S.

Automakers
Factor Endowments
y Big Three (GM, Ford, and Chrysler)

y Higher production costs
y Large pension obligations and health care
y Policy implications of Stolper-Samuelson theorem

y Even though free trade may provide overall
gains for a country

y There are winners and losers
y Owners of relatively
y abundant resources
y Favor free trade
y Owners of relatively scarce factors
y Favor trade restrictions
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Econ, 14th ed
costs
y Hundreds of thousands of retirees
y 2008,
2008 GM spentt $4
$4.8
8 billi
billion on h
health
lth care
y $1,500 higher cost per vehicle
y Higher hourly wages: $30 (and $30 in benefits)
y Toyota, Honda
y Health care costs - $200 per vehicle
y Hourly wages: $24 (and $24 in benefits)
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TABLE 3.5 Labor-cost gap per vehicle hurts competitiveness of big three
automakers
Factor Endowments
y International trade - substitute for migration?
y Immigrants
y Help the economy grow
y Increasing the size of the labor force
y Complementary: take low skilled jobs few
native-born are available to work

y Complementary: take jobs that contribute to
technological innovation
y Competition: displace locals
y Growth: immigrant entrepreneurs generate
new industries and jobs

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Factor Endowments
y Specific-factors theory
y Substitute for the movement of resources from
y Income distribution effects of trade
one country to another

y International movements in resources are not
essential
y International trade in products can achieve the
same result
y Complement labor migration, short and nearlong terms
y Expanding trade some unemployed workers
y Forced to seek employment abroad

Econ, 14th ed
Sem I 2014-5
Factor Endowments
y International trade
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y In the short term

y When resources are immobile among
industries
y Resources specific to import-competing
industries
y Lose as a result of trade
y Resources specific to export industries
y Gain as a result of trade
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Does Trade Make the Poor Even Poorer?
y Wage gap: skilled and unskilled workers
y Wage ratio
y Some combination of trade, technology,
y Wage of skilled workers divided by the wage of
education, immigration, and union weakness

y Income inequality - pervasive
y Wages
g of skilled workers relative to those of
unskilled workers
y Outcome of the interaction between supply
and demand in the labor market
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FIGURE 3.3
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unskilled workers
y Labor ratio
y Quantity of skilled workers available divided by
the quantity of unskilled workers
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Inequality of wages between skilled and unskilled workers
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y International trade and technological change
y Increase in the demand curve of skilled workers
relative to unskilled workers

y Higher degrees of wage inequality
y Immigration
y Decrease in the supply of skilled workers
y Higher wage inequality
By increasing the demand for skilled relative to unskilled workers, expanding trade or
technological improvements result in greater inequality of wages between skilled and unskilled
workers. Also, immigration of unskilled workers intensifies wage inequality by decreasing the
supply of skilled workers relative to unskilled workers. However, expanding opportunities for
college education results in an increase in the supply of skilled relative to unskilled workers, thus
reducing
wage inequality. In the figure, the wage ratio equals wage of skilled workers/wage of
23
unskilled
workers.
labor ratio
equals
AT-Int
Econ 103A;
Textbook:The
R. Carbaugh,
Int Econ,
14th edthe quantity of skilled workers/quantity of unskilled
workers

Econ, 14th ed
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Does a flat world make Ricardo wrong?
y Education and training
y Critiques of globalization
y Increase in the supply curve of skilled workers
y The world has become flat

y Reduce the wage inequality
y Sources of wage inequality
y Trade and immigration
y Small effects
y Domestic sources, especially technology
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y Comparative advantages dwindled / or dried
up
y China and India economic development;
p
;
more similar to U.S.

y A level playing field
y Internet, wireless technology, search engines,
other innovations.
y United States could become worse off with
trade
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FIGURE 3.4
Does a flat world make Ricardo wrong?
Sem I 2014-5
Education, skill intensity, and U.S. import shares,

1998
y Problems with this critique

y Globalization - increased international economic
interdependence
y Ignores the ways in which modern trade differs
from Ricardos simple model

y The world is not flat at all
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The figure suggests that countries that are abundant in skilled labor capture
larger shares of U.S. imports in industries that intensively use those factors.
Conversely, countries that are abundant in unskilled labor capture larger shares
of
28 U.S. imports in industries that intensively use those factors.

Econ, 14th ed
Sem I 2014-5
FIGURE 3.5 Economies of scale as a basis for trade
Increasing Returns to Scale

y Increasing-returns trade theory
y Nations with similar factor endowments
y Negligible comparative-advantage differences
y May find it beneficial to trade
y Because they can take advantage of massive
economies of scale
y Produce that good in great quantity at low
average unit costs
y Trade those low-cost goods to other nations
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By adding to the size of the domestic market, international trade permits longer
production runs by domestic firms, which can lead to greater efficiency and
reductions
in unit costs.
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Overlapping Demands as a Basis for Trade
External Economies of Scale

y External economies of scale
y Theory of overlapping demands, Linder, 1960s
y The average cost of the typical firm decreases
y Factor-endowment theory - explains trade in
primary products and agricultural goods

y Not trade in manufactured goods
y Force influencing
g manufactured-good
g
trade
y Domestic demand conditions
y Firms within a country manufacture goods for
which there is a large domestic market
y A nations exports - extension of the
production for the domestic market
y As the output of the industry within this area
increases
y Concentration of an industrys
y firms in a
particular geographic
y Larger pools of a specialized type of worker
y New knowledge about production technology
spreads among firms in the area
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Econ, 14th ed
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y Consumer demand - conditioned strongly by
y Nations with similar per capita incomes
income levels
y A countrys average or per capita income will
yield a particular pattern of demand
y Nations with high per capita incomes will
demand high-quality manufactured goods
(luxuries)
y Nations with low per capita incomes will
demand lower-quality goods (necessities)
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y Overlapping demand structures

y Consume similar types of manufactured
goods
g
y Wealthy (industrial) nations
y More likely to trade with other wealthy nations
y Poor (developing) nations
y More likely to trade with other poor nations
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Intra-industry Trade
y Intra-industry specialization, trade
y Production of particular products or groups of
y Involves flows of goods with similar factor
products within a given industry

y The opening up of trade does not generally
result in the elimination or wholesale
contraction of entire industries within a nation
y The range of products produced and sold by
each nation changes
y Emphasized by advanced industrial nations

Econ, 14th ed
Sem I 2014-5
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requirements
y Conducted mostly among industrial countries
y Similar resource endowments
y Firms oligopolies
y Trade in homogeneous goods
y Transportation costs
y Seasonal
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TABLE 3.7
Intra-industry trade examples: selected U.S. exports and

imports, 2007 (in millions of dollars)

y Trade in differentiated products
y Unmet need
y Overlapping demand segments in trading
nations
y Economies of scale
y Fewer adjustment problems
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Technology: The Product Cycle Theory
y Technological innovations
y Product life cycle theory
y Different nations, at different rates of speed
y Predictable trade cycle:
y Result in:
1.
y New methods of producing existing
commodities
2.
y Production of new commodities
3.
y Commodity improvements
4.
y Often transitory
5.
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Econ, 14th ed
Sem I 2014-5
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Manufactured good is introduced to home

market
Domestic industry
y shows export
p
strength.
g
Foreign production begins
Domestic industry loses competitive
advantage
Import competition begins
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The Product Cycle Model
y International product cycle

Stage II
Stage I
y U.S. and Japanese radio manufacturers
Stage V
Stage IV
Stage III
y U.S. and Japanese pocket calculators
Imports
manufacturers
Innovating
Country
Exports
Imitating
Exports
Country
Imports
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Dynamic Comparative Advantage: Industrial

Policy
Time
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Dynamic Comparative Advantage: Industrial

Policy
y Dynamic comparative advantage
y Industrial policy
y Comparative advantage in a particular industry
y Antitrust immunity, tax incentives, R&D
y Can be created
subsidies, loan guarantees, low-interest-rate

loans, trade protection
y Requires government to identify the winners
y And encourage resources to move into
industries with the highest growth prospects
y Mobilization of skilled labor, technology, and
capital
p
y Industrial policy
y Government is actively involved in creating
comparative advantage
y Strategy to revitalize, improve, and develop an
industry
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Econ, 14th ed
Sem I 2014-5
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Government Subsidies Support

Boeing and Airbus

Boeing and Airbus
y Industrial policy
y Boeing, United States
y Government subsidies commercial jetliner
y Airbus receives unfair subsidies from
industry
y Worlds manufacturers of commercial jetliners
y Oligopolistic
g p
market
y Dominated by
y Boeing of the United States
y Airbus Company of Europe
European governments
y Allegedly:
y Loans for the development
p
of new aircraft
y Below-market interest rates
y 70-90% of an aircrafts development cost
y Repay the loans after it delivers an aircraft
y Can avoid repaying the loans in full if sales of
its aircraft fall short
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Boeing and Airbus
y Airbus
y Defended its subsidies
y Indirect subsidies
y Prevent U.S. from holding a worldwide
y Support for commercial jetliner innovation -
monopoly in commercial jetliners

y Boeing
g benefits from government
g
assistance
y Indirect subsidies
y Support aeronautics and propulsion research
government organizations

Econ, 14th ed
Sem I 2014-5

Boeing and Airbus
y Airbus
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military-sponsored research and military

procurement
y Subcontracts part of the production of its
jetliners to Japan and China
y Receive substantial governmental subsidies
y Tax breaks
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Transportation Costs
Government Regulatory Policies

y Government regulations
y Workplace safety
y Costs of moving goods
y Occupational Safety and Health
y Freight charges
Administration
y Product safety
y
y Consumer Product Safety Commission
y Clean environment
y Environmental Protection Agency
y May improve the wellbeing of the public
y Can result in higher costs for domestic firms
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y Packing and handling expenses

y Insurance premiums
y An obstacle to trade
y Impede the realization of gains from trade
liberalization
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y Differences across countries in transport costs
y Source of comparative advantage
y Reduce the volume of trade
y Affect the volume and composition of trade
y Reduce the degree of specialization in
production
y Trade effects of transportation costs
y Reduce the g
gains from trade
y The high
high-cost
cost importing country
y One possible reason for international wage
y Produce more, consume less, and import less
differential
y The low- cost exporting country

y Produce less, consume more, and export less
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TABLE 3.9 Size of transportation costs, selected countries, 2007
y Falling transportation costs since 1965
y Imports - more competitive in U.S. markets
y Higher volume of trade for U.S.
y Due to technological improvements
y Large dry-bulk
dry bulk containers
y Large scale tankers
y Containerization
y Wide-bodied jets
y Telecommunications
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Rising energy costs hinder trade flows
y Growing international trade
y Rising sensitivity to increased energy costs
y Falling transportation costs
y Shift toward containerization
y Worldwide decrease in trade barriers
y Speed
y Economic opening of nations that have
y Transport costs
traditionally
y been minor p
players
y
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Rising energy costs hinder trade flows

y Rising shipping costs
y Terrorist attack
y Trade should be both dampened and diverted
y Added costs
y Substitute goods - from closer locations
y Slowdowns for U.S. freight system
y Sizable surcharges on domestic shipments by
y Security can become a new kind of trade barrier
train and truck

y Congested domestic transportation systems
y May slow the outsourcing of goods in the future
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International Econs Notes 2

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Prof Augustine H H Tan

pre-trade relative product prices of trading

Sources off Comparative

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

y Ultimate determinants of comparative

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

AT-Int Econ 103A; Text: R. Carbaugh, Int

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

y Determines comparative advantage

relatively scarce resource

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

Prof Augustine H H Tan

Producing aircraft and textiles: factor endowments in the

y Effect of resource endowments on comparative

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

Capital stock per worker of selected countries, 1997*

y Factor-endowment theory, U.S.-China trade

scientific talent, and engineering talent are

AT-Int Econ 103A; Text: R. Carbaugh, Int

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

Prof Augustine H H Tan

U.S.-China trade: top ten products, 2007 (thousands of

y Factor-endowment theory, U.S.-China trade

skilled labor and technology

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

FIGURE 3.2 The factor-price equalization theory (b)

y Until price equalization occurs

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

AT-Int Econ 103A; Text: R. Carbaugh, Int

Prof Augustine H H Tan

TABLE 3.4 Indexes of hourly compensation, manufacturing workers,

Education, training, skill, and the like

y Not all countries use the same technology

New and better technology replaces older

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

Globalization drives changes for U.S.

y Big Three (GM, Ford, and Chrysler)

y Policy implications of Stolper-Samuelson theorem

gains for a country

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

AT-Int Econ 103A; Text: R. Carbaugh, Int

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

Prof Augustine H H Tan

native-born are available to work

new industries and jobs

y Substitute for the movement of resources from

y Income distribution effects of trade

one country to another

AT-Int Econ 103A; Text: R. Carbaugh, Int

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

y In the short term

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

Prof Augustine H H Tan

Does Trade Make the Poor Even Poorer?

Does Trade Make the Poor Even Poorer?

y Wage gap: skilled and unskilled workers

y Some combination of trade, technology,

y Wage of skilled workers divided by the wage of

education, immigration, and union weakness

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

the quantity of unskilled workers

Inequality of wages between skilled and unskilled workers

AT-Int Econ 103A; Textbook: R. Carbaugh, Int Econ, 14th ed

Does Trade Make the Poor Even Poorer?