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International EconomicsInternational Trade(Comparative advantage –lecture 3)

Prof. Maurizio PugnoUniversity of Cassino

University of CassinoEconomics and BusinessAcademic Year 2019/2020

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Comparative Productivity Advantage and the Gains from Trade

� Question: What happens if a country does not have an absolute productivity advantage in anything?

� Answer: Even if a country does not have any goods with an absolute productivity advantage, it can still benefit from trade- The idea that nations benefit from trade has nothing to do with whether a country has an absolute advantage in producing a particular good

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Example

13Steel

1.22Chips

MalaysiaUSOutput per hourworked

� The US has an absolute advantage in both chips (2>1.2) and steel (3>1).

� � Malaysia has a relative advantage (notabsolute!) in producing Chips:

>

>

1

2.1

3

2 <

4

Prices for the US and for Malaysia

steel

chips

300

200

0.67

1.5 .B

1.2

.83

165

198

PPC(US)

PPC(Malaysia)If Malaysia has resources =165 hours (and the US =100)

PPC(M): chips=198-1.2*steel PPC(US): chips=200-0.67*steel

tons

chipsP s

US 67.0=chips

tonsPc

US 5.1=

tons

chipsP s

Malaysia 2.1=chips

tonsPc

Malaysa 83.0=

Absolute adv. disappear here

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Gains from trade

� For the US, it is convenient to buy chips in Malaysia because their (relative) price is lower:

� For Malaysia, it is convenient to buy steel in the US because its (relative) price is lower:

� Therefore, for both countries it is convenient to exchange steel for chips. Both gain from trade.

chips

tonsPc

Malaysa 83.0=chips

tonsPc

US 5.1=

tons

chipsP s

US 67.0=tons

chipsP s

Malaysia 2.1=

<

<

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At what prices the US trades with Malaysia?

Initial assumptions- Production at B (135,110)- The US can trade with Malaysia.� Prices are within the ranges:

eg: Ps=1 and Pb=1.

steel

chips

300

110 .

1

B

1351.2

1.5

Malaysia prices

US prices

World prices

2.167.0 =<<= sMalaysia

sW

sUS PPP

5.183.0 =<<= cUS

cW

cMalaysia PPP

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Quantifying gains from trade

For every ton of steel sold to Malaysia, the US gives up 0.67 chips. The US can now trade 1 ton of steel for 1 chip, thus (net) gaining 0.33 chips (1 - 0.67 = 0.33).

steel

chips

300

200

.67

1.5 .B

1

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Towards specializationIt is convenient to trade steel for chips, up to produce only steel and no chips at B’(300,0).The US can export (a portion of 300 of) steel at Ps=1, and import chips at Pb=1.But how much export?

steel

chips

300

200

.

1 B’ (complete specialization)

B

ConsumptionPossibility Curve

PPC

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Trade of the US with Malaysia

AssumptionThe US consume 135 and export 165(=300-135) of steel.

ResultThe US would import 165(=165*1) of chips with a net gain of 55(=165-110) of chips

steel

chips

300

200

.

1

B

imports

ofchips

net g

ain

exports ofsteel

110

135

1.2

US-PPC

CPC

pricesin

Malaysia

165

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Trade of Malaysia with the US

steel

chips

0.67.1.2

0.83prices in the US

M-C

PC

PPCexpo

rts

ofch

pis

imports of steel

165

137,5

33

198

If Malaysia specializesin chips, if it consumes 33, then it exports 165(=198-33) of chips.Malaysia would import 165(=165*1) of steel with a net gain of 27.5(=165- 137.5) of steel.

198

1

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Less gains from trade with relative advantage

113steel

1.232bread/chips

MalaysiaCanadaUSproductivitiesComparing the gains fromcomplete specialization inthe 2 examples.

165(27.5)

165(55)

export

165(55)

330(220)

import (gain)

US

exportimport (gain)

exportimport (gain)

MalaysiaCanada

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The Ricardian Law of Comparative Advantage� If one nation has absolute disadvantage with respect

to the other nation in the production of both commodities, both nations still gain from trade.

� The first nation specializes in the production and export of the commodity in which its absolute disadvantage is smaller (this is the commodity of its comparative advantage) and import the commodity in which its absolute disadvantage is greater.

� The gain is usually greater if both nations have an absolute advantage in one commodity.

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Example of Comparative Advantage

Relative labor productivities and comparative advantage

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Example of Comparative AdvantageRelative unit labor costs and exports – US/Japan(where: unit labor cost = wage/labor productivity)

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Comparative wages (US vs Canada)

� If competitive markets prevail, then w = MPL(where: w=hourly wage; MPL=Marginal Productivity of Labor).

� Wages in terms of domestic production:= MPLs = 3 t. of steel; = MPLb = 3 l. of bread

� Wages in terms of foreign production (in case ofinternational trade):

= MPLs*(ps / pb) = 3 tons *2 = 6 loaves of bread > 3

= MPLb*(pb / ps) = 3 loaves *0.5 = 1.5 tons of st. < 3

� US workers are richer than Canada (the double).

bUSwsCw

sUSw b

Cw

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Comparative wages (US vs Malaysia)

� If competitive markets prevail, then w = MPL(where: w=hourly wage; MPL=Marginal Productivity of Labor).

� Wages in terms of domestic production:= MPLs = 3 t. of steel; = MPLc = 1.2 chips

� Wages in terms of foreign production (in case ofinternational trade):

= MPLs*(ps / pc) = 3 t.of steel *1 = 3 chips > 1.2= MPLc*(pc / ps) = 1.2 chips *1 = 1.2 t.of st.< 3

� The US is richer than Malaysia (more than double).

sMw

cMw

cUSw

sUSw

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Unequal gains (and losses) from trade� When two countries become open to trade, they move to specialization, so that:- sectors with comparative advantage grow, - sectors with comparative disadvantage shrink.This is the economic restructuring.� Labor should move from the shrinking sectors to the growing ones.� Losses from trade arise if:- this move takes time (frictional unemployment)- labor is sector specific (structural unemployment).� all consumers gain from trade, some workers lose.

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Job losses in high-import sectors in the US (1979-1999)

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US-China trade and job displacement

Source: https://www.epi.org/files/pdf/114752.pdf

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Problems with trade and politics

� Trade liberalization in the US with respect toChina since 2000 is associated to:� loss of income and employment in manufacturing� rise of deaths due to suicides, alcohol abuse� which are concentrated in some counties and among

white and male population(Pierce and Schott 2016).

� In Trump’s election, he performed best in counties� with the highest drug, alcohol and suicide mortality� with high job losses in manufacturing(Monnat 2016).

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Deindustrialization

� International trade is usually accompanied by:- technological progress (on the supply side),- consumers’ move towards services (on the demand side).

� This implies deindustrialization, i.e. severe shrinkage of manufacturing, so that:- entire groups of workers lose jobs,- entire regions become poor.

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Factors responsible for deindustrialization

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Economic Restructuring and policy

� The problems due to international trade are NOT automatically solved by the theory of comparative advantage, but they need specific policies.

� Policy may:- seek to get the winners from trade and restructuring to compensate the losers; - or impose restrictions to international trade (see next lectures).

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Conclusions on the Ricardian model� It explains why economic development is

accompanied by international trade, i.e. becausecountries thus gain from trade.

� It explains the pattern (export/import flows) ofinternational trade.

� It explains why countries may trade bymaintaining income inequality between them.

� However, it appeals to different countries’productivities without explaining them.

� It does not remedy the problem of restructuring� It’s restrictive since it assumes constant marginal

productivities, and constant returns to scale.

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The terms of trade� Definition: the ratio of the price of country’s

export commodity to the price of its import commodity.

� Since in a two-nation world, the exports of a nation are the imports of its trade partner, the terms of trade of the latter are equal to the inverse of the terms of trade of the former.

� This ratio is usually multiplied by 100 in order to express the terms of trade in %. A year is chosen as base year.

� An improvement in a nation’s terms of trade is beneficial to the nation in the sense that the prices that the nation receives for its exports rise relative to the prices that it pays for imports.

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Terms of Trade of Advanced and Developing Countries

Export Unit Value/Import Unit Value; 2000=100

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Comments on the table

� There is no uniform trends.� The dynamics of the terms of trade much

depends on the fluctuations ofcommodities.

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End of the third lectureof

International TradeM. Pugno