Gains and Losses from Trade in the Specific- Factors Model
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
Questions to Consider
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1. Do you personally gain from inexpensive imported goods?
2. Besides you, who gains and who loses from trade?
3. What government policies can help firms and workers that lose from trade?
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
Introduction (part 1)
• In December 2005, became the first Aymara Indian elected as president in Bolivia’s 180-year history.
– The new constitution (2009) gave indigenous people control over natural resources in their territories.
– The export of natural gas generated gains for the foreign-owned and state-owned companies that sold the resources, but the indigenous peoples did not historically share in those gains.
– A key lesson from this chapter is that in most cases, opening a country to trade generates winners and losers.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
Introduction (part 2)
• The argument from the Ricardian model that trade generates gains for all workers is too simple because labor is the only factor of production in that model.
• We relax that assumption with the specific-factors model, where land can be used only in the agriculture sector and
capital can be used only in the manufacturing sector; labor is used in both sectors.
• From the Ricardian model, we learned that free trade affects relative prices, and this in turn affects the earnings of factors of production.
• The question addressed by the specific-factors model is how trade, through changes in relative prices, affects the earnings of labor, land, and capital.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
1) Specific-Factors Model (part 1)
• The specific-factors model we will develop has the following features:
– Once again there are two countries: Home and Foreign.
– Manufacturing uses labor and capital, and agriculture uses labor and land.
– In each industry, increases in the amount of labor used are subject to diminishing returns; that is, the marginal product of labor declines as the amount of labor used in the industry increases.
– For now let’s focus on the Home country.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
1) Specific-Factors Model (part 2)
The Home Country
FIGURE 3-1
Panel (a) Manufacturing Output As more labor is used, manufacturing output increases, but it does so at a diminishing rate.
Panel (b) Diminishing Marginal Product of Labor An increase in the amount of labor used in manufacturing lowers the marginal product of labor.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
1) Specific-Factors Model (part 3)
• The Home Country
• Production Possibilities Frontier
FIGURE 3-2
Production Possibilities Frontier
The production possibilities frontier shows the amount of agricultural and manufacturing outputs that can be produced in the economy with labor.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
1) Specific-Factors Model (part 4)
• The Home Country
• Opportunity Cost and Prices
– As in the Ricardian model, the slope of the PPF equals the opportunity cost or relative price of the good on the horizontal axis; here it is manufacturing.
– Firms hire labor up to the point where the cost of one more hour of labor (the wage) equals the value of one more hour of labor in production.
𝑊 = 𝑃! $ 𝑀𝑃𝐿! 𝑊 = 𝑃” $ 𝑀𝑃𝐿”
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
1) Specific-Factors Model (part 5)
• The Home Country
• Opportunity Cost and Prices
FIGURE 3-3
In the absence of international trade, the economy produces and consumes at point A.
The relative price of manufactures, PM/PA, is the slope of the line tangent to the PPF and indifference curve U1, at point A.
With international trade, the economy is able to produce at point B and consume at point C.
The world relative price of manufactures, (PM/PA)W, is the slope of the line BC.
The rise in utility from U1 to U2 is a measure of the gains from trade for the economy.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
1) Specific-Factors Model (part 6)
• The Foreign Country
– Let us assume that the Home no-trade relative price of manufacturing is lower than the Foreign relative price.
𝑃! ⁄ 𝑃” < 𝑃 ∗! ⁄ 𝑃 ∗"
– This means that Home can produce manufactured goods relatively cheaper than Foreign.
– Put another way, Home has a comparative advantage in manufacturing.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
1) Specific-Factors Model (part 7)
• Overall Gains from Trade
– The good whose relative price goes up
(manufacturing, for Home) is exported.
– The good whose relative price goes down (agriculture, for Home) is imported.
– By exporting manufactured goods at a higher price and importing food at a lower price, Home is better off than it was in the absence of trade.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
APPLICATION: How Large Are the Gains from Trade? (part 1)
• There are a few historical examples of countries that have moved from autarky (i.e., no trade) to free trade, or vice versa, quickly enough to estimate the gains from trade.
• One episode occurred in the United States between December 1807 and March 1809.
• The U.S. Congress imposed a nearly complete halt on international trade at the request of President Thomas Jefferson.
• A complete stop of all trade is called an embargo. As you might expect, U.S. trade fell dramatically during this period. It is estimated that U.S. GDP was 5% lower than it would have been without the trade embargo.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
APPLICATION: How Large Are the Gains from Trade? (part 2)
• There are a few historical examples of countries that have moved from autarky (i.e., no trade) to free trade, or vice versa, quickly enough to estimate the gains from trade.
– Another historical case was Japan’s rapid opening to the world economy in 1854, after 200 years of self- imposed autarky.
– The gains were not one-sided, however; Japan’s trading partners—such as the United States—also gained from being able to trade in the newly opened markets.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
APPLICATION: How Large Are the Gains from Trade? (part 3)
Switzerland
South Africa
United Kingdom
Russian Federation
United States
Trade/GDP (%)
Gains from Trade (%)
Adjusted Gains (%)
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
2) Earnings of Labor (part 1)
• Determination of Wages
FIGURE 3-4 (1 of 2)
The amount of labor used in manufacturing is measured from left to right along the horizontal axis, and the amount of labor used in agriculture is measured from right to left.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
2) Earnings of Labor (part 2)
• Determination of Wages
FIGURE 3-4 (2 of 2)
Labor market equilibrium is at point A. At the equilibrium wage of W, manufacturing uses 0ML units of labor and agriculture uses 0AL units.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
2) Earnings of Labor (part 3)
• Change in Relative Price of Manufactures
• Now consider an increase in the price of the
manufactured good (PM).
– With an increase in the price of the manufactured good the curve PM • MPLM shifts up.
– Therefore, the labor used in manufacturing rises, and labor used in agriculture falls.
– The wages also increase, but this increase is less than the upward shift ∆𝑃! % 𝑀𝑃𝐿!
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
2) Earnings of Labor (part 4)
• Change in Relative Price of Manufactures
FIGURE 3-5
Increase in the Price of Manufactured Goods
With an increase in the price of the manufactured good, the curve PM • MPLM shifts up to PM¢ • MPLM and the equilibrium shifts from point A to B.
The labor used in manufacturing rises from 0ML to 0ML¢, and labor used in agriculture falls from 0AL to 0AL¢.
The wage increases from W to W¢, but this increase is less than the upward shift DPM • MPLM.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
2) Earnings of Labor (part 5)
• Change in Relative Price of Manufactures
• Effect on Real Wages
– As we can see from Figure 3-5, the increase in the wage from W to W′ is less than the vertical increase ΔPM • MPLM
– Since ΔW/W < ΔPM /PM , the percentage increase in the wage is less than the percentage increase in the price of the manufactured good.
– This inequality means that the amount of the manufactured good that can be purchased with the wage has fallen.
– Therefore, the real wage in terms of the manufactured good W/PM has decreased.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
2) Earnings of Labor (part 6)
• Change in Relative Price of Manufactures
• Effect on Real Wages
FIGURE 3-5
Once again, since ΔW/W < ΔPM /PM, the percentage increase in the wage is less than the percentage increase in the price of the manufactured good.
The manufactured good that can be purchased with the wage has fallen.
Therefore, the real wage in terms of the manufactured good W/PM has decreased.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
2) Earnings of Labor (part 7)
• Change in Relative Price of Manufactures
• Overall Impact on Labor
– In the specific-factors model, the increase in the price of the manufactured good has an ambiguous effect on the real wage and therefore an ambiguous effect on the well-being of workers. Although ambiguous, this conclusion is important.
– The result is different from what was found in the Ricardian model, where labor unambiguously earned a higher real wage.
– This warns us that one cannot make unqualified statements about the effects of trade on workers.
– The effect of trade on real wages can be complex.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
SIDE BAR: Do Poor or Rich Consumers Gain the Most from Trade?
• There are two channels by which changes in prices due to international trade affect individuals: through the change in the prices of goods that they buy (the spending channel) and through the change in the income that they earn (the earnings channel).
• Considering the spending channel, if the prices of food and necessities tend to fall due to international trade, then that will benefit poor consumers the most, because they spend a greater share of their income on food. It follows that the spending channel tends to benefit poor consumers the most.
• What about the earnings channel? As we will discuss in Chapter 7, international trade has tended to raise the incomes of higher-skilled individuals in the United States as compared to those with fewer skills. Thus the earnings channel tends to favor richer individuals in the United States.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
2) Earnings of Labor (part 8)
• Change in Relative Price of Manufactures
• Unemployment in the Specific-Factors Model
– It is hard to combine business cycle models with international trade models to isolate the effects of trade on workers.
– Once we recognize that workers can find new jobs—possibly in export industries that are expanding—we still cannot conclude that trade is necessarily good or bad for workers.
– Next we look at some evidence from the United States on the amount of time it takes to find new jobs and on the wages earned; we also look at attempts by governments to compensate workers who lose their jobs because of import competition. This type of compensation is called Trade Adjustment Assistance (TAA) in the United States.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
APPLICATION: Manufacturing and Services in the United States: Employment and Wages Across Sectors (part 1)
FIGURE 3-6 U.S. Manufacturing Sector Employment, 1973–2018
Employment in the U.S. manufacturing sector is shown on the left axis, and the share of manufacturing employment in total U.S. employment is shown on the right axis. Both manufacturing employment and its share in total employment have been falling over time, indicating that the service sector has been growing.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
APPLICATION: Manufacturing and Services in the United States: Employment and Wages Across Sectors (part 2)
FIGURE 3-7 (1 of 2) Real Hourly Earnings of Production Workers
This chart shows the real wages (in constant 2018 dollars) earned by production workers in U.S. manufacturing, in all private services, and in information services (a subset of all private services).
Services includes wholesale and retail trade, finance, law, education, information technology, software engineering, consulting, and medical and government services.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
APPLICATION: Manufacturing and Services in the United States: Employment and Wages Across Sectors (part 3)
FIGURE 3-7 (2 of 2) Real Hourly Earnings of Production Workers (continued)
Although wages were slightly higher in manufacturing than in all private services from 1974 through 2007, all private service wages have been higher since 2008.
This change is due in part to the effect of wages in the information service industry, which are substantially higher than those in manufacturing.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
APPLICATION: Manufacturing and Services in the United States: Employment and Wages Across Sectors (part 4)
Job Losses in Manufacturing and Service Industries, 2015–2017
This table shows the number of displaced (or laid-off) workers in manufacturing and service industries from 2015 to 2017.
Total Displaced Workers (thousands) Jan 2015–Dec 2017
PERCENTAGES:
Workers Reemployed by Jan 2018
PERCENTAGES: Of the Workers Reemployed: Earn Less in
PERCENTAGES: Of the Workers Reemployed: Earn Same or More in
Manufacturing industries
Service industries
In the three years from January 2015 to December 2017, about 479,000 workers were displaced in manufacturing and 2.2 million in all service industries. In manufacturing, 65% were reemployed by January 2018, and slightly more than one-half (53%) earned less in their new jobs, while slightly less than one-half (47%) earned the same or more. For services, 69% of workers were reemployed by January 2018, with the same percentages earning less or more in their new jobs.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
APPLICATION: The “China Shock” and Employment in the United States (part 1)
• In the specific-factors model we assumed that workers leaving one industry could be absorbed freely into the other.
• After China joined the WTO in 2001, U.S. imports from China grew rapidly, from 10% of total imports in 2001 to 23% in 2009.
• The large increase in the share of U.S. imports coming from China and its impact on employment in manufacturing are called the “China shock.”
• Studies have found that 2 million jobs or more were lost in U.S. manufacturing industries.
• In reality, we see that with a very large change in prices (as occurred with the “China shock”), it takes more than one decade for enough jobs to be created in export industries to balance the losses in import industries.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
APPLICATION: The “China Shock” and Employment in the United States (part 2)
FIGURE 3-8 Real U.S. Imports and Exports and the China Share, 1992–2018
Real values (in 2018 dollars) of U.S. nonpetroleum imports (the red line) and exports (the green line) to the world are shown on the left axis. The share of U.S. imports coming from China (the orange line) and the share of U.S. exports going to China (the light green line) are shown on the right axis.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
APPLICATION: The “China Shock” and Employment in the United States (part 3)
FIGURE 3-9 Decrease in the Price of Manufactured Goods
With a decrease in the price of manufactured goods, the curve PM • MPLM shifts down to P'M • MPLM and the equilibrium shifts from point A to point B. The amount of labor in manufacturing falls to 0ML' and the amount of labor in agriculture rises to 0AL'. The wage falls to W'.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
APPLICATION: The “China Shock” and Employment in the United States (part 4)
FIGURE 3-10 Job Gains and Job Losses in U.S. Manufacturing Industries,1991–1999, 1999–2011
For the period 1991–1999, estimated job gains due to rising U.S. exports are shown in green, and the estimated job losses due to rising U.S. imports are shown in orange. For the period 1999–2011, estimated job gains due to rising U.S. exports are shown in blue, and the estimated job losses due to rising U.S. imports are shown in red.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
3) Earnings of Capital and Land (part 1)
• Determining the Payments to Capital and Land
• If QM is the output in manufacturing and QA is the output in agriculture, the revenue earned in each industry is PM • QM and PA • QA, and the payments to capital and to land are:
• Paymenttocapital=𝑃! %𝑄! −𝑊%𝐿! Paymentstoland=𝑃" %𝑄" −𝑊%𝐿"
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
3) Earnings of Capital and Land (part 2)
• Determining the Payments to Capital and Land
• The earnings of one unit of capital (a machine, for instance), which we call RK, and the earnings of an acre of land, which we call RT, are calculated as:
𝑅# = Paymentstocapital=𝑃! 2𝑄! −𝑊2𝐿! 𝐾𝐾
𝑅$ =Paymentstoland=𝑃" 2𝑄" −𝑊2𝐿" 𝑇𝑇
• Economists call RK the rental on capital and RT the rental on land.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
3) Earnings of Capital and Land (part 3)
• Determining the Payments to Capital and Land
• Change in the Real Rental on Capital
• As more labor is used in manufacturing, the marginal product of capital will rise because each machine has more labor to work it.
• In addition, as labor leaves agriculture, the marginal product of land will fall because each acre of land has fewer laborers to work it.
• The general conclusion is that an increase in the quantity of labor used in an industry will raise the marginal product of the factor specific to that industry, and a decrease in labor will lower the marginal product of the specific factor.
© 2021 Worth Publishers International Economics, 5e | Feenstra/Taylor
3) Earnings of Capital and Land (part 4)
• Determining the Payments to Capital and Land
• With labor leaving agriculture, the marginal product
of each acre falls, so RT /PA also falls.
• The fact that RT /PA falls means that the real rental on land in terms of food has gone down, so landowners cannot afford to buy as much food.
• Thus, landowners are clearly worse off from the rise in the price of the manufactured good bec
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