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INTERNATIONAL TRADE MODELS
& ASIAN ECONOMIC GROWTH
CHIRANTAN CHATTERJEE

1
Key Notions in International Trade
1) Absolute Advantage
2) Comparative Advantage
3) Terms of Trade

2
Some Basics in International Trade
1) David Hume’s Balance of Trade 1758
2) Puzzle for class:

Over the past few decades, ...
Inspired by Physics & Newton
Newton’s Model

4
Some Basics in International Trade
1) Tinbergen’s (1962) Gravity Model

2) Economists show that 1% increase in distance be...
But Should Distance Matter?
1) Proxy for Transport Costs.
2) Proxy for ‘Time Elapsed’.
3) Proxy for ‘Transaction Cost’.

6
Augmenting the Gravity Model
1) With Income per Capita

o Many estimate gravity equations with the log of per-capita
incom...
Trade Policies & the Gravity Model
1) FTAs lead to tripling of trade between nations (Frankel &

Rose 2000)
2) Mixed resul...
The Ricardian Model
o The Ricardian model uses the concepts of opportunity
o

o

o
o

cost and comparative advantage.
The ...
The Ricardian Model

Suppose initially that Bangladesh produces computers and
the U.S. produces textile, and that both cou...
The Ricardian Model
o
o

o
o
o

o

Labor is the only factor of production.
Labor productivity varies across countries due ...
The Ricardian Model


The production possibility frontier of the home economy is:

aLCQC + aLWQW ≤ L

Labor required for
...
Labor Productivity & the Ricardian Model

13
Labor Productivity & the Ricardian Model

o
o
o
o

Home has comparative advantage in ____, foreign in _____?
aLC /aLW < a*...
Labor Productivity & the Ricardian Model

o
o
o
o

Home has comparative advantage in ____, foreign in _____?
aLC /aLW < a*...
Steady State Prices Guided by the Following Rules
If
oPC /PW < aLC /aLW < a*LC /a*LW
home or foreign

then no cheese produ...
Broadly, Trade Enhances Consumption Possibilities in the
Ricardian World

17
Ricardo Tested in China’s Emergence

o China's emergence as an export powerhouse.
o China's overall labor productivity in ...
But Trade Can Happen Not Just because Labor
Productivity Differs

19
Could Happen Because Of Differences in Resources
Endowments

20
Enter Heckscher-Ohlin Model

21
H-O: Broad Intuition from the Nobel Foundation

22
H-O: Broad Intuition from the Nobel Foundation

23
Notice the H-O set up
o 2 Countries having different relative abundance of factors
of production.
o Production processes u...
H-O Differs from the Ricardian World
o All agents gain from trade in the Ricardian world but is
that true?
o Why then some...
Samuelson on Comparative Advantage – A Detour
o A mathematician, Stan Ulam, once challenged Paul
Samuelson to name one pro...
Building Blocks: 4 Key Ideas in the H-O Model

1) The Stolper Samuelson Theorem:
o A rise in the relative price of a good ...
Building Blocks: 4 Key Ideas in the H-O Model

2) The Rybczynski theorem:
o When only one of two factors of production is ...
Building Blocks: 4 Key Ideas in the H-O Model

3) The Factor-Price Equalization Idea
o

The relative prices for two identi...
Building Blocks: 4 Key Ideas in the H-O Model
.

4)The Heckscher-Olin Theorem:
o

It states that a country will export goo...
Let’s go through the nitty-gritties of H-O: Set-Up Again

Source: Klaus Desmet Lectures

31
Production of Food

Source: Klaus Desmet Lectures

32
Prices & Uses of Inputs

Source: Klaus Desmet Lectures

33
Prices & Relative Uses of Inputs

Source: Klaus Desmet Lectures

34
The Lerner Diagram
o This is the lowest possible cost,
an UNIQUE same isocost,
tangent to the two isovalue
curves.
o Here ...
Remember Stolper-Samuelson!

1) The Stolper Samuelson Theorem:
o A rise in the relative price of a good will lead to a ris...
Understanding Stolper-Samuelson

o LHS panel indicates relationship between prices and w/r. How?
o RHS panel indicates giv...
Allocation of FOPs: The Edgeworth Box Diagram
 Given Pf/Pc, we know

Kf/Lf and Kc/Lc.
 From Origin Of we draw

a line wi...
Recap: Rybczynski Theorem

When only one of two factors of production is increased there is a
relative increase in the pro...
Rybczynski Theorem in a Edgeworth Box

o And you can then take the new Kf/Lf and Kc/Lc to that

2-sided diagram to back ou...
Rybczynski Theorem through a PPF

41
But we have still not discussed H-O’s key idea

A country will export goods that use its abundant factors
intensively, and...
To understand H-O we need to understand World RS-RD

43
Remember our Set-Up Again

Source: Klaus Desmet Lectures

44
Remember our Set-Up Again

Source: Klaus Desmet Lectures

45
World RS-RD & Autarky

 What is an autarky?
 Examples of autarky in today’s world?
 Synonym for an autarkic economy?
So...
H-O, World RS-RD & Free Trade

 Relative prices converge.
 Spain exports computers, Poland food: H-O QED.
Source: Klaus ...
Gains from Trade & It’s Political Economy







Source: Klaus Desmet Lectures

Spain can export some computers now!...
Gains from Trade & It’s Political Economy







Source: Klaus Desmet Lectures

Spain can export some computers now!...
What have we still not covered in H-O?

Source: Klaus Desmet Lectures

50
4th Tenet in H-O : Factor Price Equalization

The Factor-Price Equalization Idea
o

The relative prices for two identical ...
FPE explained in a slide

Source: Klaus Desmet Lectures

52
FPE explained in a slide
o Since:
o With Free Trade:

o Therefore:
o Or
o Similarly we can show that that the rental rate ...
FPE explained in a slide
o Since:
o With Free Trade:

o Therefore:
o Or
o Similarly we can show that that the rental rate ...
FPE explained in a slide
o Since:
o With Free Trade:

o Therefore:
o Or
o Similarly we can show that that the rental rate ...
FPE explained in a slide
o Since:
o With Free Trade:

o Therefore:
o Or
o Similarly we can show that that the rental rate ...
FPE explained in a slide
o Since:
o With Free Trade:

o Therefore:
o Or
o Similarly we can show that that the rental rate ...
When can FPE not apply?

o What if there are strategic barriers to trade?
o Could result in incomplete price equalization....
Guess Who?

59
Wassily Leontief

60
Quiz Question!

61
The Leontief Paradox
o Leontief's paradox in economics is that the country with the

world's highest capital-per worker ha...
H-O & it’s empirical relevance in Asia

Source: Bowen et.al AER 1987
63
H-O & it’s empirical relevance in Asia
 The authors calculated the ratio

of each country's endowment of
each factor to t...
Asia & ROW trade

65
H-O Effect in Bangladesh & German Exports to US

A country will export goods that use its abundant factors
intensively, an...
Rybczynski Effect in the 4 Tigers

When only one of two factors of production is increased there is a relative increase
in...
Changing Patterns in Comparative Advantage

 In

1960
4
Tigers
specialized in low-skilled
intensity goods & so was
it in ...
What did we learn today?
1) Trades induces gains.
2) The

principle behind why so, lies in understanding
‘comparative adva...
What did we learn today?
 The Stolper Samuelson Theorem:
A rise in the relative price of a good will lead to a rise in th...
What did we learn today?
 The Leontief Paradox
 H-O has mixed evidence in Asia. Japan is an exception too
 4-Tigers cha...
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Trade Models & Asian Economic Growth

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Trade Models & Asian Economic Growth

  1. 1. INTERNATIONAL TRADE MODELS & ASIAN ECONOMIC GROWTH CHIRANTAN CHATTERJEE 1
  2. 2. Key Notions in International Trade 1) Absolute Advantage 2) Comparative Advantage 3) Terms of Trade 2
  3. 3. Some Basics in International Trade 1) David Hume’s Balance of Trade 1758 2) Puzzle for class: Over the past few decades, East Asian economies have increased their share of world GDP. Similarly, Intra-Asian trade has also increased as a share of world-trade. Why? 3
  4. 4. Inspired by Physics & Newton Newton’s Model 4
  5. 5. Some Basics in International Trade 1) Tinbergen’s (1962) Gravity Model 2) Economists show that 1% increase in distance between 2 countries -> fall in 0.7-1% trade. 3) So distance does matter – One of the most Robust Economic Relationships 4) The argument behind RTAs 5
  6. 6. But Should Distance Matter? 1) Proxy for Transport Costs. 2) Proxy for ‘Time Elapsed’. 3) Proxy for ‘Transaction Cost’. 6
  7. 7. Augmenting the Gravity Model 1) With Income per Capita o Many estimate gravity equations with the log of per-capita incomes (lnM=POP) of the exporting and importing countries included as well as the log of aggregate incomes (ln M). 1) Adjacency Considerations o Examples of this phenomenon include India-Pakistan, Tijuana–San Diego, and HongKong–Shenzhen 1) Languages & Colonial Links o Two countries that speak the same language will trade more than pairs that do not share a common language. o Measures of Colonial Links & Similarity +vely correlated with Trade. 7
  8. 8. Trade Policies & the Gravity Model 1) FTAs lead to tripling of trade between nations (Frankel & Rose 2000) 2) Mixed results on Monetary Agreements o Countries that share a common currency trade like US & Panama three times more than expectation. o But some other studies have found that the triplingeffect doesn’t pan out similarly with EURO in EU. 1) What about the effect of Import Tariffs or VERs? 8
  9. 9. The Ricardian Model o The Ricardian model uses the concepts of opportunity o o o o cost and comparative advantage. The opportunity cost of producing something measures the cost of not being able to produce something else with the resources used. Example of Comparative Advantage? o A country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in the country than in other countries. (US in computers & Bangladesh in textiles) Project Socrates. Revealed Comparative Advantage o (Eij / Eit ) / ( Enj / Ent ) o 1 < (CA) ; >1 (RCA) 9
  10. 10. The Ricardian Model Suppose initially that Bangladesh produces computers and the U.S. produces textile, and that both countries want to consume computers and textiles. Can both countries be better off? 10
  11. 11. The Ricardian Model o o o o o o Labor is the only factor of production. Labor productivity varies across countries due to differences in technology, but labor productivity in each country is constant. The supply of labor in each country is constant. Two goods: wine and cheese. Competition allows workers to be paid a “competitive” wage equal to the value of what they produce, and allows them to work in the industry that pays the highest wage. Two countries: home and foreign. 11
  12. 12. The Ricardian Model  The production possibility frontier of the home economy is: aLCQC + aLWQW ≤ L Labor required for each pound of cheese produced  Total pounds of cheese produced Total amount of labor resources Labor required for each gallon of wine produced Total gallons of wine produced When does one have maximum cheese and maximum wine production? 12
  13. 13. Labor Productivity & the Ricardian Model 13
  14. 14. Labor Productivity & the Ricardian Model o o o o Home has comparative advantage in ____, foreign in _____? aLC /aLW < a*LC /a*LW Relative price of ___ to ___ higher in foreign? Home will ship ___ and foreign14 will ship ____?
  15. 15. Labor Productivity & the Ricardian Model o o o o Home has comparative advantage in ____, foreign in _____? aLC /aLW < a*LC /a*LW Relative price of cheese to wine higher in foreign? Home will ship cheese and foreign will ship wine? 15
  16. 16. Steady State Prices Guided by the Following Rules If oPC /PW < aLC /aLW < a*LC /a*LW home or foreign then no cheese production at oPC /PW = aLC /aLW < a*LC /a*LW , then domestic are indifferent, foreign produces wine. oaLC /aLW < Pc /PW < a*LC /a*LW , then? o aLC /aLW < a*LC /a*LW < PC /PW, & now? 16
  17. 17. Broadly, Trade Enhances Consumption Possibilities in the Ricardian World 17
  18. 18. Ricardo Tested in China’s Emergence o China's emergence as an export powerhouse. o China's overall labor productivity in the mid-90s was still lower than some American/European standards. o But in some specific industries, they did have comparative advantage with the disadvantage dissipating. o In those industries, it was one of the largest producers and exporters. o China's relative productivity in apparel was higher than rest of manufacturing. It had 8 times the size of Germany's apparel industry. 18
  19. 19. But Trade Can Happen Not Just because Labor Productivity Differs 19
  20. 20. Could Happen Because Of Differences in Resources Endowments 20
  21. 21. Enter Heckscher-Ohlin Model 21
  22. 22. H-O: Broad Intuition from the Nobel Foundation 22
  23. 23. H-O: Broad Intuition from the Nobel Foundation 23
  24. 24. Notice the H-O set up o 2 Countries having different relative abundance of factors of production. o Production processes use factors of production with different relative intensity. o One can classify these countries: home and foreign. Two goods: cloth and food. Two factors of production: labor and capital. o The mix of labor and capital used varies across goods. o The supply of labor and capital in each country is constant and varies across countries. o In the long run, both labor and capital can move across sectors, equalizing their returns (wage and rental rate) across sectors. 24
  25. 25. H-O Differs from the Ricardian World o All agents gain from trade in the Ricardian world but is that true? o Why then some are anti-trade and some are pro-trade? o Is a single-factor of production a realistic assumption? o For that matter 2 factors of production? o Ricardian world advocates ‘complete specialization’ – but is that realistic? o But H-O also extends the Ricardian notion of ‘comparative advantage’ but conditional on resource endowments – we will shortly see how. 25
  26. 26. Samuelson on Comparative Advantage – A Detour o A mathematician, Stan Ulam, once challenged Paul Samuelson to name one proposition in the social sciences that is both true and non-trivial. o His reply was: ‘the theory of comparative advantage’. o “That it is logically true need not be argued before a mathematician; that is not trivial is attested by the thousands of important and intelligent men (and women) who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them. ” 26
  27. 27. Building Blocks: 4 Key Ideas in the H-O Model 1) The Stolper Samuelson Theorem: o A rise in the relative price of a good will lead to a rise in the return to that factor which is used most intensively in the production of the good, and conversely, to a fall in the return to the other factor. 27
  28. 28. Building Blocks: 4 Key Ideas in the H-O Model 2) The Rybczynski theorem: o When only one of two factors of production is increased there is a relative increase in the production of the good using more of that factor. This leads to a corresponding decline in that good's relative price as well as a decline in the production of the good that uses the other factor more intensively. 28
  29. 29. Building Blocks: 4 Key Ideas in the H-O Model 3) The Factor-Price Equalization Idea o The relative prices for two identical factors of production will eventually be equalized international trade. 29 across countries because of
  30. 30. Building Blocks: 4 Key Ideas in the H-O Model . 4)The Heckscher-Olin Theorem: o It states that a country will export goods that use its abundant factors intensively, and import goods that use its scarce factors intensively. In the two-factor case, it states: "A capitalabundant country will export the capital-intensive good, while the labor-abundant country will export the labor-intensive good." 30
  31. 31. Let’s go through the nitty-gritties of H-O: Set-Up Again Source: Klaus Desmet Lectures 31
  32. 32. Production of Food Source: Klaus Desmet Lectures 32
  33. 33. Prices & Uses of Inputs Source: Klaus Desmet Lectures 33
  34. 34. Prices & Relative Uses of Inputs Source: Klaus Desmet Lectures 34
  35. 35. The Lerner Diagram o This is the lowest possible cost, an UNIQUE same isocost, tangent to the two isovalue curves. o Here : • r*Kf + w*Lf = r*Kc + w*Lc • Slope = w/r. • We should be able to find for each Pf/Pc , w/r Source: Klaus Desmet Lectures 35
  36. 36. Remember Stolper-Samuelson! 1) The Stolper Samuelson Theorem: o A rise in the relative price of a good will lead to a rise in the return to that factor which is used most intensively in the production of the good, and conversely, to a fall in the return to the other factor. 36
  37. 37. Understanding Stolper-Samuelson o LHS panel indicates relationship between prices and w/r. How? o RHS panel indicates given w/r, relative use of K/L. o Pf/Pc w/r Kf/Lf & Kc/Lc Source: Klaus Desmet Lectures 37
  38. 38. Allocation of FOPs: The Edgeworth Box Diagram  Given Pf/Pc, we know Kf/Lf and Kc/Lc.  From Origin Of we draw a line with slope of Kf/Lf and from Oc with slope Kc/Lc.  Intersection point is point of allocation of Kf, Lf, Kc, Lc.  Can we end up outside the box? How Source: Klaus Desmet Lectures 38
  39. 39. Recap: Rybczynski Theorem When only one of two factors of production is increased there is a relative increase in the production of the good using more of that factor. This leads to a corresponding decline in that good's relative price as well as a decline in the production of the good that uses the other factor more intensively. 39
  40. 40. Rybczynski Theorem in a Edgeworth Box o And you can then take the new Kf/Lf and Kc/Lc to that 2-sided diagram to back out new Pf/Pc 40
  41. 41. Rybczynski Theorem through a PPF 41
  42. 42. But we have still not discussed H-O’s key idea A country will export goods that use its abundant factors intensively, and import goods that use its scarce factors intensively. In the two-factor case, it states: "A capital-abundant country will export the capital-intensive good, while the laborabundant country will export the labor-intensive good." 42
  43. 43. To understand H-O we need to understand World RS-RD 43
  44. 44. Remember our Set-Up Again Source: Klaus Desmet Lectures 44
  45. 45. Remember our Set-Up Again Source: Klaus Desmet Lectures 45
  46. 46. World RS-RD & Autarky  What is an autarky?  Examples of autarky in today’s world?  Synonym for an autarkic economy? Source: Klaus Desmet Lectures 46
  47. 47. H-O, World RS-RD & Free Trade  Relative prices converge.  Spain exports computers, Poland food: H-O QED. Source: Klaus Desmet Lectures 47
  48. 48. Gains from Trade & It’s Political Economy       Source: Klaus Desmet Lectures Spain can export some computers now! Relative price of food falls in Spain – what about in Poland? Spain’s real wage ____ and rental rate _____? Poland’s real wage ____ and rental rate ____ ? Who will be pro-trade/against-trade in Spain? In Poland? 48
  49. 49. Gains from Trade & It’s Political Economy       Source: Klaus Desmet Lectures Spain can export some computers now! Relative price of food falls in Spain – in Poland it rises. Spain’s real wage falls and rental rate rises. Poland’s real wage rises and rental rate falls. Workers in Spain protest. Capital owners in Poland protest. 49
  50. 50. What have we still not covered in H-O? Source: Klaus Desmet Lectures 50
  51. 51. 4th Tenet in H-O : Factor Price Equalization The Factor-Price Equalization Idea o The relative prices for two identical factors of production will eventually be equalized across countries because of international trade. Source: Klaus Desmet Lectures 51
  52. 52. FPE explained in a slide Source: Klaus Desmet Lectures 52
  53. 53. FPE explained in a slide o Since: o With Free Trade: o Therefore: o Or o Similarly we can show that that the rental rate r also converges. Source: Klaus Desmet Lectures 53
  54. 54. FPE explained in a slide o Since: o With Free Trade: o Therefore: o Or o Similarly we can show that that the rental rate r also converges. Source: Klaus Desmet Lectures 54
  55. 55. FPE explained in a slide o Since: o With Free Trade: o Therefore: o Or o Similarly we can show that that the rental rate r also converges. Source: Klaus Desmet Lectures 55
  56. 56. FPE explained in a slide o Since: o With Free Trade: o Therefore: o Or o Similarly we can show that that the rental rate r also converges. Source: Klaus Desmet Lectures 56
  57. 57. FPE explained in a slide o Since: o With Free Trade: o Therefore: o Or o Similarly we can show that that the rental rate r also converges. Source: Klaus Desmet Lectures 57
  58. 58. When can FPE not apply? o What if there are strategic barriers to trade? o Could result in incomplete price equalization. o Or if technology changes – Remember the Trade Contest! o + Do countries produce both goods always? 58
  59. 59. Guess Who? 59
  60. 60. Wassily Leontief 60
  61. 61. Quiz Question! 61
  62. 62. The Leontief Paradox o Leontief's paradox in economics is that the country with the world's highest capital-per worker has a lower capital/labor ratio in exports than in imports. This econometric finding was the result of Leontief's attempt to test the Heckscher–Ohlin theory empirically. o In 1954, Leontief found that the United States—the most capital-abundant country in the world—exported laborintensive commodities and imported capital-intensive commodities, in contradiction with Heckscher–Ohlin theory. o Stern & Maskus (1981) later find that the answer lies by factoring in a 3rd factor of production. o Guess which? o Factoring in Natural Resources makes the Leontief Paradox go away – some other day. 62
  63. 63. H-O & it’s empirical relevance in Asia Source: Bowen et.al AER 1987 63
  64. 64. H-O & it’s empirical relevance in Asia  The authors calculated the ratio of each country's endowment of each factor to the world supply of that factor.  They then compared this ratio with the country's share of world income.  If FPE is correct, countries would always export factors, for which the factor share > income share.  But for 2/3rd of the FOPs trade ran in the predicted direction less than 70% of time. Source: Bowen et.al AER 1987 64
  65. 65. Asia & ROW trade 65
  66. 66. H-O Effect in Bangladesh & German Exports to US A country will export goods that use its abundant factors intensively, and import goods that use its scarce factors intensively. In the two-factor case, it states: "A capital-abundant country will export the capital-intensive good, while the labor-abundant country will export the labor-intensive good." Source: Romalis (2004) 66
  67. 67. Rybczynski Effect in the 4 Tigers When only one of two factors of production is increased there is a relative increase in the production of the good using more of that factor. This leads to a corresponding decline in that good's relative price as well as a decline in the production of the good that uses the other factor more intensively. Source: Romalis (2004) 67
  68. 68. Changing Patterns in Comparative Advantage  In 1960 4 Tigers specialized in low-skilled intensity goods & so was it in Japan.  By 1998, the situation was starting to change in both.  The role of public policy 68 Source: Krugman et.al (2011)
  69. 69. What did we learn today? 1) Trades induces gains. 2) The principle behind why so, lies in understanding ‘comparative advantage’ & its link to resource endowments. 3) The gravity model is one of the most robust relationships in economics. 4) Which is why Asia’s intra-regional trade is very high. 5) H-O model has 4 predictions 69
  70. 70. What did we learn today?  The Stolper Samuelson Theorem: A rise in the relative price of a good will lead to a rise in the return to that factor which is used most intensively in the production of the good, and conversely, to a fall in the return to the other factor.  The Rybczynski theorem: When only one of two factors of production is increased there is a relative increase in the production of the good using more of that factor. This leads to a corresponding decline in that good's relative price as well as a decline in the production of the good that uses the other factor more intensively.  The Factor-Price Equalization Idea Factor Prices Equalize in the long run due to trade.  The Heckscher-Olin Theorem Countries exports goods conditional on its resource abundance. Capitalintensive countries will export capital goods (US-computers) and laborabundant country exports the labor-intensive goods (Bangladesh–textiles). 70
  71. 71. What did we learn today?  The Leontief Paradox  H-O has mixed evidence in Asia. Japan is an exception too  4-Tigers changes the terms-of-trade over time.  Next Class: Strategic Trade Policies & Protectionism & Globalization of the Value Chain & Implications for Trade. 71

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