international trade
dodo1995
moisespowerpointchapter6.pptx6 Is Free Trade a Rip-off for OECD Workers?
International Trade
ECON 1086/ ECON 1089
The OECD
Five facts.
Since the 1970’s, developed economies have grown quite well. Along with this, labor productivity grew.
Over the same period, wages started to lag behind productivity growth.
Inequality in wages also increased; median wages have been stagnant, and below-median male wages have fallen.
This coincides with the big wave of globalization.
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The figure shows the evolution of the distribution of real wages for U.S. men since 1970 by deciles.
Labelled 10 for the first decile through 90 for the top decile and normalized so that all variables take a value of 100 in 1973.
The median (50th percentile) wage takes approximately the same value at the end of the data that it did 32 years earlier.
At the same time, the wages at the high end of the distribution have increased significantly, and the wages at the low end have fallen significantly.
For example, the 90th percentile wage has increased by about 30%, while the 20th percentile wage has dropped by about 8%. Half of the workforce has actually lost ground.
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Question:
Did free trade cause these labor-market problems?
Note the problem with post-hoc reasoning.
Read slide, then say:
Causation is very difficult to prove in economics. Once again, a post- hoc argument needs to be used with care, as it is possible that both the globalization and the labor market problems were caused by different factors, or by a common factor, as opposed to the former causing the latter.
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One way of testing for causation:
Formalize the simplest model that predicts free trade leads to stagnation or reductions in incomes of low-wage OECD workers.
Then see what other predictions the model has, and test those.
This model is the Heckscher-Ohlin model.
This can then be tested using regression analysis (GMM).
Heckscher-Ohlin.
Comparative-advantage model in which trade is driven by differences in factor endowments across countries.
Let’s assume there are only two countries: US and China.
Two goods: Apparel and Plastics.
Two factors of production: Skilled and unskilled labor.
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We’ll go through the model with fixed-coefficients production because it’s easier to understand that way.
We assume that each country’s factor supplies are fixed;
Each factor is mobile within its country (no specific factors);
All agents take prices as given.
Produce 1 unit of apparel: Requires, by minimum, 1 unit of skilled labor and 2 units of unskilled labor. (Activity coefficients).
Produce 1 unit of plastics: Requires 3 units of skilled and 3 units of unskilled labor.
Apparel is unskilled-labor intensive; plastics are skilled-labor intensive.
Note: Relative terms: comparison of skilled-to-unskilled labor ratio in the two industries.
Assume that the US has 72 million unskilled workers, 60 million skilled workers.
Assume that China has 540 million unskilled workers, 300 million skilled workers.
US is skilled-labor abundant (or skilled-labor rich);
US is unskilled-labor scarce (or unskilled-labor poor);
China is unskilled-labor abundant (or unskilled-labor rich);
China is skilled-labor scarce (or skilled-labor poor).
Note that these are relative terms.
China in this example has more skilled workers than the US.
That doesn’t make it unskilled-labor abundant; it’s the ratio that matters.
Unskilled labour market
WU
LU
DU
Skilled labour market
WS
LS
DS
Relative labour supply
US
China
Relative demand
This summary is from Leamer (1995).
Learner, Edward E. 1995. "A Trade Economist's View of U.S. Wages and Globalization." In Susan Collins, ed., Imports, Exports, and the American Worker. Washington, D.C: Brookings Institution.
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The relative endowments of labor tell us if we are better at producing plastic or apparel.
If we have a lot of unskilled labor relative to skilled labor, unskilled wages are relatively low.
So we are better at producing apparel than plastic.
And vice versa
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Relative supply of apparel to plastic does not depend on PA/PP.
This is because we get a fixed supply based on endowments.
This is an assumption of this model.
Therefore, curve is....
.... vertical.
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Suppose we doubled the endowment of both kinds of labor -- the relative supply of apparel would.....
... not change.
Therefore, we can think of RS as a function of LU/LS alone.
Now, is it increasing or decreasing in LU/LS?
What happens if we raise LU without changing LS?
The economy becomes intensive in unskilled labor.
Increase in supply of unskilled labor makes it cheaper to produce apparel.
Supply of apparel increases.
Relative supply increases.
RSUS
Answer: QA goes up, and QP goes down.
This is called the Rybczynski theorem.
Consequence: RS is increasing in LU/LS.
The Rybczynski theorem says that an increase in the supply of one factor will increase the output of the good that is intensive in that factor, and a reduction in the output of the other good.
The Rybczynski theorem says that (holding output prices constant) an increase in the supply of one factor will increase the output of the good that is intensive in that factor, and a reduction in the output of the other good.
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The world relative supply curve is be obtained from the individual countries’ supplies.
Read this, then press next to activate the animation.
Working out the analogue to the equations above with 540 million unskilled workers and 300 million skilled workers, we find that China produces 240 million units of apparel and 20 million units of plastics, for a relative supply of 12. Both countries’ relative supply curves are shown in Figure 6.6, marked RSUS and RSCH , respectively.
If we assume that all consumers in both countries have the same relative demand curve, we can then solve for autarky equilibrium in both countries.
To complete our example, suppose that the relative demand curve is the line marked as RD in the figure, and the autarky relative prices of apparel for the United States and China are given by 0.48 and 0.37, respectively
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Relative price
Output (depends solely on relative supply of labor)
Relative demand
Here you can draw the figure from the previous slide to explain things again. You can draw in a rich and poor country.
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Each country exports the good that is intensive in the factor in which it is abundant.
This is called the Heckscher-Ohlin theorem.
I have a relatively large amount of unskilled labour, so I export unskilled labor-intensive goods.
I have a relatively large amount of skilled labour, so I export skilled labor-intensive goods.
Note that at the free-trade equilibrium, China’s relative supply of apparel (12) exceeds its relative demand for apparel (7), so it exports apparel and imports plastics.
The United States’ relative demand for apparel (7) exceeds its relative supply (0.75), so it imports apparel and exports plastics.
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Income distribution.
What happens to skilled/unskilled wages?
Price
Output
D
Imports and exports
S
Imports
Exports
Imports and exports
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Unskilled labour market in the US
WU
LU
DU
Skilled labour market in the US
WS
LS
DS
Inequality
Relative labour supply
US
China
World
Relative demand
Demand for U↓ because less of U-intensive good is made in the US.
Demand for U↑ because more of U-intensive good is made in China.
This summary is from Leamer (1995).
Learner, Edward E. 1995. "A Trade Economist's View of U.S. Wages and Globalization." In Susan Collins, ed., Imports, Exports, and the American Worker. Washington, D.C: Brookings Institution.
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Stolper-Samuelson
Exporting skilled labor intensive goods leads to an increase in relative demand for skilled labor.
This drives relative skilled wages up.
Inequality increases.
Opposite is true for China.
This is the Stolper-Samuelson theorem.
Summary so far.
Heckscher-Ohlin provides a theory that predicts because of the opening of trade:
US wage inequality rises.
Lower-wage workers are hurt.
Higher-wage workers benefit.
Is this the explanation? Is free trade a rip-off for OECD workers?
One way of testing this.
Look for other predictions of the model and see if they pan out.
For example:
Prediction. In high-per-capita income countries, relative skilled wages rise, but in low-per-capita income countries they fall.
Evidence on Prediction.
The figure shows data on inequality over time for a wide range of countries. For each country, the vertical axis measures the change in inequality from 1980 to 1990, and the horizontal axis measures the 1980 income per capita.
Therefore, the countries are lined up from the poorest on the left to the richest on the right.
Note that the great majority of the data points lie above the horizontal axis, meaning that in the great majority of countries income inequality rose.
Since this was a period of rapid globalization worldwide, Prediction 3 calls for a positive relationship between the two variables, as higher-income countries should be more likely to see an increase in inequality than low-income ones. However, there is no such positive relationship in the figure. In fact, the two variables show a negative correlation (-0.35), and a linear best-fit to the scatterplot, shown as a black line, shows a negative slope. For countries at the lowest income levels, such as Cameroon and Bangladesh, income inequality was much more likely to go up than down. We can conclude that the data reject Prediction 3 as well.
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The Heckscher-Ohlin theory doesn’t explain all outcomes in practice.
Does it explain outcomes in your country?.
Evidence from East Asia does follow the H-O story!
This is probably because East Asia focused on export-oriented growth of manufactures.
Lets look at data from James K. Galbraith
Of the
The University of Texas Inequality Project
These data are for manufacturing only, giving us a cleaner story!
The Scale
Brown: Very large decreases in inequality; more than 8 percent per year.
Red Moderate decreases in inequality.
Pink: Slight Decreases.
Light Blue: No Change or Slight increases
Medium Blue: Large Increases -- Greater than 3 percent per year.
Dark Blue: Very Large Increases -- Greater than 20 percent per year. h
1981 to 1987
… the Age of Debt
Note the exceptions to rising inequality are mainly India and China, neither affected by the debt crisis…
1984 to 1990
1988 to 1994
The age of globalization…
Now the largest increases in inequality in are the post-communist states; an exception is in booming Southeast Asia, before 1997…
Conclusion.
The Heckscher-Ohlin model offers a plausible theory that makes trade the culprit.
Most economists conclude that trade is not the only culprit.
(There’s something else going on that it much bigger.)
So what is the culprit?
....Literature on this does not agree on an answer.
Possible culprits -- all disputed.
Pervasive skill-biased technical change (pervasive SBTC). (Lect. 5)
Decline of unions.
Decline of real value of minimum wage.
Immigration (really disputed; see Lect. 11).
Outsourcing/offshoring (disputed; see Lect. 11).
Most likely a combination of factors.
