Transcript Slide 1

Specific factors and Costs of
Adjustment
International Trade – Session 2
Daniel TRAÇA
1
A summary of the last session
• Globalization
– Growth of Trade and Foreign Direct Investment; Mostly among rich
countries;
– Developing countries rising fast (East Asia) but still small;
• Comparative advantage: a key concept!
– Global output increases when countries specialize in goods where the
relative productivity is higher.
– It can be due to relative differences in the productivity of labor.
|2
This session
• Competitiveness and Comparative Advantage
• Specific factors and costs of adjustment
• Decreasing returns and incomplete specialization
|3
The myth of competitiveness
• Free trade is beneficial only if your country is productive enough to
stand up to international competition.
– Not true! Trade is always possible and beneficial for both parties, if
markets are at work.
• A country can always be competitive in the industry where it has
comparative advantage. How?
– Its wages will be lower than the more productive country.
– It is different from firms. Countries do not compete for workers, like
firms do! Firms that are not productive within a country cannot compete
because, if they pay lower wages, they will not attract workers.
|4
Wages and productivity
• Less productive countries will compensate by paying lower wages.
– Lower wages are the result of lower productivity.
• In most countries, this is due to:
– Bad infrastructure
Insufficient investment
– Low education
Poor institutions
Productivity (%US level)
1963-1996 % increase
1963
1996
Productivity
Real wages
United States
100
100
49
34
Germany (W)
58
91
133
220
Japan
32
76
260
220
South Korea
14
50
432
n.a.
|5
The competitiveness of sectors of
comparative advantage
•
An industry is competitive if its productivity advantage vis-à-vis its foreign
competitors is higher than the country’s wage disadvantage. This will
happen in industries with comparative advantage.
– The wage gap will among countries correspond to their average productivity gap.
– In the industry of comparative advantage, the productivity gap will be wider than
the wage gap.
•
So, if in an industry we see differences in wages that are larger than the
productivity differences, that is OK! It just means that one is the sector of
comparative advantage.
|6
The case where FACTORS cannot
adjust
UN→ UN(average) are the gains from
exchange.
• They occur because, in autarky, North
had too much Manuf relative to Food,
compared to the South.
• So, even if production does not change,
there are incentives to exchange Manuf
for Food with the South.
UN(average) → UN(Manuf) are the gains
from specialization.
•They occur when resources are able to
move to the sector of comparative
advantage (Manuf in the North).
North
Manuf
10
UN(Manuf)
Average [production =
consumption] basket in
autarky
UN(average)
UN
At home:
do the same exercise
for the South!
UN(Food)
10
Food
|7
If Adjustment costs are high, trade
becomes highly political
Effects in the North
Effects in the South
The North imports Food, and the price of Manuf
The South imports Manuf, and the price of Manuf
rises relative to autarky
falls relative to autarky
•The Manuf producers in the North (exporters)
•The Food producers in North (exporters) are
are better off, but ...
better off, but ...
• Food producers (import-competing) are worse
• Manuf producers (import-competing) are worse
off
off
•The gains outweigh the losses and the average
•The gains outweigh the losses and the average
worker is still better off.
worker is still better off.
•The North is a net producer of Manuf, for which
•The South is a net consumer of Manuf, for which
the price has risen.
the price has fallen.
International Trade has positive benefits (gains from exchange), but is hot politics. It is similar to
technological progress that displaces workers.
|8
The Political Economy
•
What happened to the owners of the specific factors?
– In the North, the rising price of Manuf has benefited Capital owners, but it has
hurt Land owners.
– In the South, the declining price of Manuf has hurt Capital owners, but it has
benefited Land owners.
– The impact for workers that are mobile is ambiguous. In the North, the wage
grew for those that consume food, but declined for those that enjoy Manuf.
•
But the net gains are positive.
– It should be possible to take from the winners to compensate the losers, but this
compensation is difficult.
– Again, a political quagmire due to specific factors, that will lead to pressure for
protection.
• Example: the plight of landowners
|9
Dealing with Adjustment Costs
• Trade losers: a concern?
– Is trade different from technological innovation?
• Losers may be able to find new jobs at lower wages: in the US, wage losses upon
reemployment (+ or - 13%) are similar to the rest of manufacturing
• Trade politics
– Organization matters, and losers are more likely to get organized.
– The small gains of the many versus the large losses of the few.
• Temporary measures may help smooth the costs.
– Subsidies and Protectionism
– Without credibility, they become permanent and are very costly
|10
Costs of Protectionism
United
States
1994
Japan
1989
Korea
1990
European
Union
1990
21
47
49
20
Billions of US$
70*
74 - 110
12 - 13
67 - 100
Share of GDP (%)
1.2*
2.6 – 3.8
3.8 – 4.3
1.1 – 1.6
Average tariff equivalent (%)
35
180
170
40
Jobs “saved”
190
180
174 - 405
1,500
0.2
0.3
0.9 – 2.0
1.1
170
600
33 – 67
70
# industries surveyed
Consumer cost
(‘000)
Share of total employment
Cost per job saved
(‘000 US$)
* Estimates for the whole economy. The 21 highly protected industries were responsible for $32b.
(incl. $24b for textile and apparel). The remaining data concerns only the highly protected industries.
|11
A simple example:
Portugal and the textile industry
•
•
The sector represents more than 200,000 jobs, 16% of total exports and
2% of GDP
What are the net effects of trade with China?
– Assumptions:
• With free-trade in textiles, wholesale prices fall by around 30%
• At this Free-Trade price, no domestic producers will survive
• Workers will not find jobs elsewhere
Item / Year
Total Annual Salaries
Nbr. Workers
Turnover
Sales Margin
Producer Surplus (A+D*C)
2001
1,478,561,061 €
225,869
8,339,000,000 €
1.63%
1,614,210,624 €
2002
1,460,088,852 €
243,263
8,198,000,000 €
2.08%
1,630,345,581 €
2003
1,231,216,573 €
223,723
7,784,000,000 €
1.74%
1,366,632,932 €
F Consumption (C)
G % Var. Price
H
Gains Consumer Surplus (F*G)
per job saved (H/B)
6,574,000,000 €
30%
1,972,200,000 €
8,732 €
6,420,000,000 €
30%
1,926,000,000 €
7,917 €
6,247,000,000 €
30%
1,874,100,000 €
8,377 €
357,989,376 €
295,654,419 €
507,467,068 €
A
B
C
D
E
Gains from Trade (H-E)
|12
Short-term protection… becomes
long-term! An example
Establishing the MFA
December, 1955
Japan (MITI) unilaterally restrains exports
of cotton fabrics and clothing to USA "to
promote mutually beneficial relations".
November, 1960
GATT Contracting Parties recognize the
problem of "market disruption", even if it is
just threatened.
February, 1962
The Long Term Arrangement (LTA) is
agreed, to commence October 1, 1962, to
last for five years.
April, 1967
Agreement is reached to extend the LTA
for three vears.
October, 1970
Agreement is reached to extend the LTA
for three years. It was later extended three
months more, to fill the gap until the MFA
came into effect.
December, 1973
The MFA is agreed, to commence January
1, 1974, and to last for four years.
December, 1977
The MFA is extended for four years.
December, 1981
The MFA is renewed for five years. The
Reagan administration, under pressure from
increased imports resulting, from dollar
appreciation, negotiates tough quotas.
July, 1991
The MFA is extended pending outcome of the
Uruguay Round negotiations.
December, 1993
The Uruguay Round draft final act provides for
a l0 year phase-out of all MFA and other
quotas on textiles in Agreement on Textiles
and Clothing (ATC).
January 1, 1995
1st ATC tranche liberalized by importing
countries -16% of 1990 import volume.
January 1, 1998
2nd ATC tranche liberalized by importing
countries - 17% of 1990 import volume.
January 1, 2002
3rd ATC tranche liberalized by importing
countries -18% of 1990 import volume.
January 1, 2005
4th ATC tranche liberalized by importing
countries - 19% of 1990 import volume.
|13
Dealing with Adjustment Costs
• Unemployment subsidies
• e.g. the Trade Adjustment Assistance in the US
– Danger: discouraging job-search and creating long-term
unemployment.
• Retraining
– The difficulty is that the mean worker displaced in manufacturing
in the US is aged 38.6, has 12.3 years of education, and has a
job tenure of of 6.5 years
– Life-long learning is a better option.
|14
Incomplete specialization I
The equilibrium with constant returns
•
•
In each sector, workers must be
hired until the marginal worker’s
cost (the wage) is equal to its
marginal product.
w
Workers must be indifferent
between the two sectors
MPLF
w = MPLF = MPLM x P
Recall that P is the relative price of
manufactures
•
•
MPLM x
PAUT
MPLM x
PTRADE
In autarky, the price must equate
the relative marginal product, to
ensure both goods are produced.
If the trade price (of manufactures)
is lower than in autarky, the
country will specialize completely
in Agro/Food
LF
LM
total labor force
|15
Incomplete specialization II
The equilibrium with decreasing returns
• Once again, the equilibrium
entails
w
w = MPLF = MPLM x P
• For any given price (P), we can
find out the employment and
output of Agro/Food and
Manufactures.
• If the trade price (of
manufactures) is lower than in
autarky, the country will
specialize, but not
LF
completely, in Agro/Food
LM
total labor force
|16
Incomplete specialization III
Decreasing returns and the concavity of the PPF
• We can obtain the PPF, for the
case of decreasing returns.
Manuf
– The PPF is concave. The
opportunity cost of Food is
now increasing.
-1/P
-1
Equilibrium:
P = MPLF/MPLM
+1
Slope =
-MPLM / MPLF
• For any price (P), we can
obtain the Relative Supply of
Manuf.
-6
+1
Food
|17
Incomplete specialization III
The gains from trade in the North
•
Manuf
The prices of manufactures rises
in the North,
– Due to its comparative advantage
in manufacturing
-1/Pw
•
Exports
-1/PN
– Effects on consumption of
manufactures depend on income
(+) and substitution effect.
Gains from
trade
Imports
Production of manufactures for
export increases;
•
But there is incomplete
specialization,
– The North still produces some
Food for its own consumption
Food
|18
Equilibrium productivity and
comparative advantage
• In the trade equilibrium, we have:
[MPM/MPF]N = Pw = [MPM/MPF]S
– If the price is the same, the relative productivities are the same.
• With similar relative productivities, how can comparative
advantage emerge?
– It must be measured out of equilibrium, for the same relative
employment level.
|19
Summary
•
In countries with lower productivity, competitiveness in world markets arises
from lower wages.
– The gains from trade mean potential gains for workers.
•
The political argument is due to adjustment costs (specific factors)
–
–
–
–
•
Factors that are specific to import-competing industries will loose out from trade.
Those that are specific to exporting industries will be winners.
But the gains of winners always outweigh the loses of losers.
Compensating losers is a difficult task!
Incomplete specialization arises when marginal productivities are
decreasing.
– In this case, the relative marginal products are the same with trade.
– Comparative advantage must be seen for the same relative employment levels.
|20