Factor Immobility, Unemployment, Wages, Prices, and International Trade: Challenges - PowerPoint Presentation

1. Factor Immobility, Unemployment, Wages, Prices, and International Trade: Challenges to the Role of Trade in the H-O FrameworkSherman RobinsonIFPRIFAO worksop: “Relationship Between Trade and Food Security”Rome, March 2015

2. Benefits of International TradeTheory of comparative advantageNecessary and sufficient conditions to generate tradeDavid RicardoHeckscher-Ohlin-Samuelson (HOS)Major theorems: Trade and WagesStolper-SamuelsonRybczynskiFactor Price Equalization (Samuelson)2

3. Theory of Comparative AdvantageCountries trade because they are “different”Technology (Ricardo) and factor endowments (HOS) David Ricardo: Theory of Comparative AdvantageCountries differ only in technology: different relative productivity of factors leads to trade“Absolute” productivity differences do not affect tradeHOS: general equilibrium modelDifferent relative factor endowments leads to trade3

4. Gains from TradeIn moving from autarky, all countries gain:Mutually beneficial exchangeThe gain arises from being able to consume “off” the PPF—not constrained by production aloneNot everyone gains:Producers and factors: some gain, some lose Consumers gain: their effective real income rises, and they change consumption patterns4

5. Trade FallaciesCountries lose from trade if they are less produc-tive in all sectors—no “absolute” advantageNot true. Comparative, not absolute, advantage determines gains from tradeLabor (“jobs”) in high wage countries will be seriously damaged by trade with low-wage countries (Perot-Choate on NAFTA)Trade effects on wages are weak. But labor will be reallocated across sectors as a result of trade.5

6. 6World Prices and Wages Stolper-Samuelson Theorem: Trade matters a lotRelative factor prices are determined solely by relative goods prices Changes in world commodity prices should generate large changes in domestic factor prices: magnification effectTrade policy that affects links between world prices and domestic prices (e.g., tariffs) will have strong effects on wagesTrade policy matters a lot

7. Factor Endowments and Wages Rybczynski TheoremChanges in relative factor supplies affect structure of production and trade, but not wagesMagnification effect: changes in structure of production are larger than changes in relative factor suppliesNo role for labor economists and partial equilibrium analysis of labor markets. Wages are determined by general equilibrium trade effects and world prices, not factor endowments. 7

8. 8Labor Economists: Partial Equilibrium, Factor Content AnalysisPartial equilibrium models: wages determined in the labor marketSupply of labor: endowments, skills, education, etc.Demand for labor: technology, demand, tradeUnskilled-labor-intensive imports displace unskilled-labor-intensive domestic productionFactor content of net tradeWorsening of U.S. trade deficit contributes to a widening wage gap because it increases unskilled-labor-intensive importsNo room for these effects in trade theory

9. Trade/Wage DebateIn the HOS model, world commodity markets drive national factor marketsThese results are not supported by econometric analysis and simulation models of wage-trade links—Stolper-Samuelson and Rybczynski effects are much weaker than theory would predictEconometric analysis of labor markets supports view that wages are sensitive to changes in factor endowments and nature of labor markets9

10. Factor Price Equalization TheoremIf two countries with identical technologies but different factor proportions (e.g., K/L ratios) trade freely, factor prices will equalize (Samuelson)Trade in goods equalizes factor prices, “substituting” for trade in factors (e.g., foreign investment) Assumption of “identical technology” is very strong: only difference is factor endowmentsVery “delicate” theorem: not supported by empirical work (econometrics and simulation)10

11. Stolper-Samuelson TheoremWhat happens if the world price of a traded commodity changes? An increase in the relative price of a good will increase the real return to the factor used intensively in that good, and reduce the real return to the other factor.Jones: Magnification Effect. The percent change in factor prices will exceed the change in product prices. Distributional implications of changes in trade11

12. Rybczynski TheoremWhat happens if there is uneven factor growth in a country (e.g., K/L rises), with no change in world prices? Output of the sector intensive in the growing factor increases, while output in the other sector decreases. Factor prices (e.g., wages, profits) will NOT changeMagnification effect: percent output changes will exceed percent factor endowment changes12

13. Summary: Major Theorems(1) Factor price equalization: free trade will result in factor prices being identical across countries(2) Rybczynski: An increase in the endowment of a factor at constant commodity prices will increase absolutely the production of the good which uses that factor intensively, and decrease absolutely production of the other good(3) Stolper-Samuelson: A rise in the price of a good raises absolutely the real return to the factor used intensively in the production of that good, and decreases absolutely the real return to the other factorMagnification Effect in both Stolper-Samuelson and Rybczynski Theorems 13

14. HOS Empirical ModelsStolper-Samuelson implies that tariffs should have a major impact on wages and outputRemoving tariffs (liberalization) should have a major impact (e.g., magnification effect)Rybczynski implies major changes in trade structure with growth in endowmentsEmpirical results with simulation models indicate much smaller impacts than these theorems imply14

15. HOS Empirical ModelsTwo major issues that the HOS model neglects:Role of non-traded goodsSpecific factors: tied to particular sectorsNon-traded goodsLong understood that existence of non-traded goods qualifies the major theorems. How qualified? Specific factors: issues of factor mobilityShort versus long run “frictions”—how important? Role of labor markets in trade models15

16. 16Trade Model with Differentiated GoodsExpand the HOS model to include goods that are differentiated by country of originArmington insight: Traded and domestic goods are imperfect substitutesThe model can accommodate “two-way trade” observed in the data: more realistic than HOSWeaker link between world and domestic pricesSpecification is standard in all trade-focused CGE simulation models

17. Trade-Wages in CGE ModelsImplications of the Armington assumptionAssumption of imperfect substitutability greatly improves the realism of trade simulation models (e.g., CGE models)Robinson, Thierfelder, de Melo, Devarajan and others have worked out the analytics of the HOS model with the Armington specificationTrade shares matter substitution/transformation elasticities matter17

18. 18Trade Theorems: Analytic ResultsStolper-Samuelson TheoremSign of wage effect depends on Armington elasticityMagnification effect greatly weakenedRybczynski TheoremMagnification effect greatly weakenedWages change with changes in factor suppliesTrade balance changes affect wagesSign opposite from that of labor economistsRoom for labor economists: endowments matter Migration and skill upgrading more important than commodity prices

19. Trade and Growth: New Trade TheoryTrade-productivity-growth links. The failure of “standard” trade theory to account for growth led to what Thierfelder and Robinson call “The Search for Large Numbers”Rent seeking, imperfect competition, challenge-response models, research, etc. Stylized facts: globalization, evolution of trade blocs, supply/value chainsNeed for trade theory to catch up with trends19

20. Trade Theory, Regional Integration,Regional Trade Agreements (RTAs) and Economic DevelopmentSherman RobinsonIFPRIMarch 2015

21. 21Stylized Facts: Post War 20th CenturyDramatic changes in global trade structuresInitial dependent trade patterns changed rapidlyEmergence of regional trade blocsIncreased trade as share of GDPLargest increase in trade among OECD countriesIncreased trade in intermediate inputsImport content of exports increasedInternational segmentation of production: value chainsStrong link between trade and growthNo example of rapid growth without rapid trade increase

22. 20th Century: Evolution of Trade BlocsIn the post-war period, the global trading system recovered from Great Depression and WW II disruptions“De-colonization” and emergence of new countries with changing economic linksRe-orientation of regional trade patternsEmergence of new “trade blocs”Center-periphery and new regional groupings22

23. Trade Blocs: 1960s23

24. Trade Blocs: 1970s24

25. Trade Blocs: 1980s25

26. Trade Blocs: 1990s26

27. 27Export Shares: 1960sEurope +N America +Asia-UKAsia-USTotalEurope +75.414.28.22.3100N America +37.544.58.39.7100Asia-UK48.812.720.618.0100Asia-US23.037.319.520.2100

28. 28Shares of World Trade: 1960sEurope +N America +Asia-UKAsia-USTotalEurope +39.77.54.31.252.7N America +11.213.32.52.929.9Asia-UK5.01.32.11.910.3Asia-US1.62.61.41.47.1Total57.624.710.37.4100

29. Export Shares: 1990s29EU+NAFTA+E&SE AsiaMercosurSACU+ROWTotalEU+73.59.310.81.20.64.5100.0NAFTA+19.349.424.12.50.44.2100.0E&SE Asia17.925.051.20.90.54.4100.0Mercosur27.520.916.322.70.911.7100.0SACU+41.511.926.82.08.19.7100.0ROW32.121.235.52.20.98.0100.0

30. Shares of Global Trade: 1990s30EU+NAFTA+E&SE AsiaMercosurSACU+ROWTotalEU+33.64.24.90.60.32.145.8NAFTA+3.89.84.80.50.10.819.9E&SE Asia4.96.813.90.30.11.227.2Mercosur0.40.30.30.40.00.21.6SACU+0.20.10.20.00.00.10.6ROW1.61.11.80.10.00.45.1Total44.622.325.91.80.64.8100.0

31. 31Implications of New Trade BlocsThe formation of blocs pre-dated any explicit regional trade agreement (RTA): very powerful global trendsRTAs validate these trends, not cause them Three kinds of RTA:Bloc creation: EU, NAFTA, MercosurBloc expansion: EU expansion, CAFTAMarket access: EPAs, AGOA, FTAA, TPP, many bilateral agreementsRTAs in these categories differ in motivation, scope, and structure—goal should be to manage the process

32. 32New RegionalismIncreased geographical dispersion of production through trade that supports (1) exploitation of different factor proportions for parts of the production process (Ricardian efficiency gains) and/or (2) local economies of scale through finer specialization and division of labor in production (“Smithian” efficiency gains)Externalities arising from institutional changes and linkages that lead to a wide increase in productivity

33. 33Trade-Productivity LinksValue chains: mechanisms differ from earlier trade-industrialization linksScale economies: Smithian gains Applies to many sectors—more economic activityAgriculture, Manufacturing, and ServicesConsistent with new “challenge” trade modelsMelitz model: trade moves producers to the frontierImport Substitution Industrialization (ISI) strategy: no longer relevant—the world has changedPolicy: facilitate and mange the process, not fight it

34. 34Shallow and Deep IntegrationEarly RTAs and GATT rounds facilitated shallow integration: Reduction of border trade barriers: PTA, FTA, CUNew RTAs involve elements of “deep integration”“Behind the border” policies to facilitate trade and value chains: e.g., standards, commercial law, dispute resolution, intellectual property, etc. Trans-Pacific Partnership (TPP) and Trans-Atlantic Trade and Investment Partnership (TTIP)

35. New RTAs: TPP ExampleTrans-Pacific Partnership: US, Canada, 10 Asia-Pacific countries (does not include China)Deep integration: includes broad range of “behind the border” regulatory, IP, standards, dispute resolution, and legal issuesE.g., “regulatory coherence”: adopt US methods of evaluating regulatory regimes (cost-benefit analysis)Adopt “standard” (US) IP (e.g., patent law)35

36. New RTAs: TPP ExampleNew dispute resolution mechanism: “Investor-State Dispute Settlement” (ISDS) Allow foreign companies to challenge domestic laws that “damage” them before an international panel of arbitrators. Can determine damages, with no recourse to domestic legal system (e.g., national courts). Only “international investors” (e.g., multinational corporations) have “standing”—not labor unions, etc. Response to worries about corrupt domestic legal systems in developing countries36

37. RTAs: TPP ExampleDispute resolution and IP issues are especially worrisome for developing countriesThey are designed to benefit large, multinational corporationsNeed to create “development friendly” RTAsFinancial sector: regulation issuesResponse: focus on “national treatment”: foreign and domestic producers should be treated “equally” within countries37

38. RTAs: ConclusionRTAs that facilitate trade, international value chains, and productivity-trade links are beneficialRTAs need to be “development friendly”Piketty: return to 19th century levels of inequalityGlobal “assault” on labor: stagnant wages, attack on unions, pensions, benefits, workers’ comp insuranceShredding of the social safety netFinancial institutions: out of control, destabilizingDeep integration RTAs that facilitate these attacks and trends need to be resisted and modified38

39. References on Trade Theory39

40. ReferencesThierfelder, Karen and Sherman Robinson. 2003. “Trade and Tradability: Exports, Imports, and Factor Markets in the Salter-Swan Model.” The Economic Record, Vol. 79, No. 244, March, pp. 103-111. de Melo, Jaime, and Sherman Robinson. 1989. “Product Differentiation and the Treatment of Foreign Trade in Computable General Equilibrium Models of Small Economies.” Journal of International Economics. Vol. 27, Nos. 1-2, pp. 47-67. Devarajan, Shantayanan, Jeffrey D. Lewis, and Sherman Robinson. 1993. “External Shocks, Purchasing Power Parity, and the Equilibrium Real Exchange Rate.” World Bank Economic Review. Vol. 7, No. 1, pp. 45-63. Devarajan, Shantayanan, Delfin S. Go, Jeffrey D. Lewis, Sherman Robinson, and Pekka Sinko. 1997. "Simple General Equilibrium Modeling." In Joseph F. Francois and Kenneth A. Reinert, eds., Applied Methods for Trade Policy Analysis: A Handbook. Cambridge: Cambridge University Press.40

41. ReferencesDevarajan, Shantayanan, Jeffrey D. Lewis, and Sherman Robinson. 1990. "Policy Lessons from Trade-focused, Two-sector Models." Journal of Policy Modeling 12(4): 625-57.Robinson, Sherman and Karen Thierfelder. 2002. “Trade Liberalisation and Regional Integration: The Search for Large Numbers.” Australian Journal of Agricultural and Resource Economics, Vol. 46, No. 4 (December), pp. 585-604.Devarajan, Shantayanan and Sherman Robinson. 2013. “Contribution of Computable General Equilibrium Modeling to Policy Formulation in Developing Countries.” In Peter B. Dixon and Dale W. Jorgenson, eds., Handbook of Computable General Equilibrium Modeling, Volume 1A. Amsterdam: Elsevier/North Holland. Pp. 277-302. 41

42. References on Regionalism, Trade, and Growth42

43. 43ReadingsBurfisher, Mary, Sherman Robinson, and Karen Thierfelder. 2004. “Regionalism: Old and New, Theory and Practice.” In G. Anania, M. E. Bohman, C. A. Carter and A. F. McCalla, eds., Agricultural Policy Reform and the WTO: Where Are We Heading?, Edward Elgar, Cheltenham, UK & Northampton MA, USA. Also available as MTID Discussion Paper No. 65, Markets, Trade and Institutions Division, IFPRI, February, 2004.IDS Asian Drivers Team (2006). “The Impact of Asian Drivers on the Developing World.” IDS Bulletin, Vol. 37, No. 1 (January), pp. 3-11.Evans, David, Raphael Kaplinsky, and Sherman Robinson (2006). “Deep and Shallow Integration in Asia: Towards a Holistic Account.” IDS Bulletin, Vol. 37, No. 1 (January), pp. 12-22. Burfisher, Mary, Sherman Robinson, and Karen Thierfelder. 2002. “The Global Impacts of Farm Policy Reforms in Organization for Economic Cooperation and Development Countries.” American Journal of Agricultural Economics, Vol. 84, No. 3 (August), pp 774-781.

44. 44ReadingsSchiff, M. and L. A. Winters (2003). Regional Integration and Development. Oxford University Press. Chapters 2, 3Baldwin R. E. (1997). “The causes of regionalism”, The World Economy, 20, pp. 865-88.Baldwin, R., J. Francois and R. Portes (1997). “The costs and benefits of EU enlargement to the East”, Economic Policy, 24, 125-176.World Bank (2000) Trade Blocs, World Bank, Washington, DC.World Bank. 2004. Global Economic Prospects, 2005: Trade, Regionalism, and Development. Washington: World Bank.

45. 45ReadingsRodriguez, F. and Dani Rodrik (2001) “Trade policy and economic growth: a skeptic’s guide to the evidence.” NBER Macroeconomics Annual, 2000, Vol. 15, MIT Press.Rodrik, Dani (1999) The New Global Economy and Developing Countries: Making Openness Work, Overseas Development Council, Washington. Winters L A (2000) “Trade Policy as Development Policy: Building on Fifty Years’ Experience “, Proceedings for High Level Round Table ,Tenth United Nations Conference on Trade and Development, Bangkok, February, 2000. Greenaway, David (1988). Economic Development and International Trade. Macmillan. Chapters by Reidel (3: “Trade as an engine of growth”) and Milner (4: “Trade strategies and development”).