Citizen Preferences over trade & what governments might do about it (brought to you by: Factors, Sectors, & Institutions)
Plan for THIS PART tonight: 1.Why do countries engage in trade? 2.Why does a country have a “comparative advantage” in one industry but not another? 3.Why is there protectionism? 4.Who is against immigration? 5.Is it factors or sectors?
Take-away: Abundant factors win from globalization (intuition: supply & demand) In a closed economy (autarky), Papa Smurf is in high demand. And he has a lot of cheap labor. But imagine there’s another country out there with lots of “Papas” and only one regular smurf. If these countries trade, the supply of Papa-goods (for the 1 st country) goes way up (and the price way down) Meantime, the demand for regular smurf-goods (worldwide) goes way up – and so does their price. WINNERS FROM TRADE! LOSERS FROM TRADE!
Why do countries engage in trade? Ricardian model: 2 countries, 2 goods & CONSTANT opportunity costs Logic of COMPARATIVE ADVANTAGE
One American worker can produce more computers or more shoes than one Brazilian worker US has an ABSOLUTE ADVANTAGE in both computers and shoes So why trade? Example is a li’l out of date…
Differences in opportunity costs! Suppose we move one American worker from Computers to Shoes We lose 50 computers for 200 shoes For each additional pair of shoes produced, the US must forgo 0.25 computers (50/200=¼) The (constant) opportunity cost of each pair of shoes is ¼ computer The (constant) opportunity cost of each computer is 4 pairs of shoes (200/50=4)
Differences in opportunity costs! Suppose we move one Brazilian worker from Computers to Shoes We lose 5 computers for 175 shoes For each additional pair of shoes produced, Brazil must forgo 0.03 computers (5/175=0.029) The (constant) opportunity cost of each pair of shoes is 0.03 computer The (constant) opportunity cost of each computer is 35 pairs of shoes (175/5=35)
Critical point Where is it RELATIVELY cheaper to produce computers? –In the US it costs 4 shoes –In Brazil it costs 35 shoes Where is it RELATIVELY cheaper to produce shoes? –In the US it costs 0.25 computer –In Brazil it costs 0.03 computer
Why does one country have a comparative advantage in one area? Heckscher-Ohlin: Compared to the availability of capital & labor in one country, another country will have relatively more or less Capital-abundant countries: Cost of capital relative to wages is lower Labor-abundant countries: Wages relative to cost of capital is lower H-O suggests that countries have an advantage in producing different commodities because of the different factor endowments of countries and the different mixtures of these factors involved in production of different commodities
Winners & Losers Trade: distributional consequences! Trade policy: –shaped by government-responses to interest groups’ demands Government-responses: –shaped by POLITICAL INSTITUTIONS
Factor incomes & class conflict Simplest version: –labor v. capital –(workers v. owners of capital) Countries have a comparative advantage in producing goods requiring their ABUNDANT FACTOR There are capital-abundant countries & labor abundant countries
In the factor model, trade causes… Income of the ABUNDANT factor to RISE Income of the SCARCE factor to FALL
Absent trade –“Capital” is relatively scarce in a country like China, so the “rent” can be enormous –Labor is abundant, so wages are low By opening up to trade –Capital “rents” will fall until they equals the (rising) rate of return in trading partner countries –Wages will rise until they equal the (falling) wage in trading partner countries
Absent trade –Labor is relatively scarce in a country like Switzerland, so wages can be enormous –Capital is abundant, so returns are low By opening up to trade –Return to capital will rise until it equals the (dropping) rate in trading partner countries –Wages will drop until they equal the (falling) wage in trading partner countries
Stolper-Samuelson Theorem Factor-price equalization The tendency for trade to cause factor prices to converge Note that the losses for the scarce factor are NOT sufficiently offset by gains from trade (even if the net aggregate gains offset net aggregate losses). The scarce factor is a net LOSER!
What do we do about losers? Repress them? –Dictatorship – repression? –Democracy – tyranny of the majority? Compensate them? –Training? –Retirement packages? Protect them? –Tariffs, barriers to trade, subsidies The answer may depend on political institutions!
Thought experiment Suppose 2 factors of production –(labor & capital) The majority of citizens are “labor” Under democracy, labor rules Under dictatorship, capital rules Question: Will the government be pro-trade or not?
DemocracyAuthoritarian Capital abundant??? Labor abundant
Back to 2 factors (ignoring collective action problem) DemocracyAuthoritarian Capital abundantLabor loses from trade but has political power protectionism Labor abundant???
Back to 2 factors (ignoring collective action problem) DemocracyAuthoritarian Capital abundantLabor loses from trade but has political power protectionism ??? Labor abundantLabor wins from trade & has political power free trade
DemocracyAuthoritarian Capital abundantLabor loses from trade but has political power protectionism Capital wins from trade & has political power free trade Labor abundantLabor wins from trade & has political power free trade ??? Back to 2 factors (ignoring collective action problem)
DemocracyAuthoritarian Capital abundantLabor loses from trade but has political power protectionism Capital wins from trade & has political power free trade Labor abundantLabor wins from trade & has political power free trade Capital loses from trade but has political power protectionism
Does the factor-approach predict preferences over “globalization”? Trade, immigration…
Effect of education on pro-trade attitude by country-factor endowment
Effect of occupational skill on pro-trade attitude by ctry-factor endowment
Who is against immigration? Mayda, Anna Marie. 2006. Who is Against Immigration? A Cross-Country Investigation of Individual Attitudes toward Immigrants. The Review of Economics and Statistics 88 (3):510-530.
Theory: The Prediction In countries characterized by *high skill* composition of natives relative to immigrants, –*skilled* individuals should favor immigration –*unskilled* individuals should oppose immigration In countries characterized by *low skill* composition of natives relative to immigrants, –*unskilled* individuals should favor immigration –*skilled* individuals should oppose immigration
The skill composition of natives to immigrants is positively correlated with GDP per capita (level of development.
The effect of education (skill) is stronger in more developed countries.
The effect of education appears to be economically not culturally driven – holds only for people in the labor force
Effect of education on pro-immigration attitude by ctry-factor endowment
Alternative explanations? Non-economic variables also matter Concerns about crime rates and cultural effect of foreigners covary with immigration attitudes Racist feelings have a very strong, negative and significant impact on pro-immigration preferences Economic findings are "robust" to the inclusion of cultural variables Important (and sad): non-economic determinants are relatively more important than the economic variables (explain more variance) –R2 of model with/without the economic variables increases 6% –R2 of model with/without the cultural variables increases 15%
Factor mobility The ease with which labor and capital can move from one industry to another We have implicitly assumed that capital and labor are highly MOBILE All capital is the same (computers, car factories, etc…) All labor is the same (shoe-makers, furniture- makers, steel-workers, etc…) But what if factors are highly SPECIFIC?
Sector Incomes & Industry Conflict It’s really about computers, shoes, etc… Factor mobility is low Incomes of labor AND capital in the same SECTOR (industry) rise and fall together Now we do not completely abandon the factor model We still use the factor model to tell us which industries benefit from trade, however,… LABOR & CAPITAL EMPLOYED IN INDUSTRIES THAT RELY INTENSIVELY ON SOCIETY’S ABUNDANT FACTOR BOTH GAIN FROM TRADE
Advanced industrial countries Capital abundant, so… Capital AND labor employed in capital- intensive industries both gain from trade The export-oriented SECTOR Capital AND labor employed in labor- intensive industries both lose from trade The import-competing SECTOR
Developing countries Labor abundant, so… Capital AND labor employed in _______- intensive industries both gain from trade The export-oriented SECTOR Capital AND labor employed in _______- intensive industries both lose from trade The import-competing SECTOR
Summarizing factors & sectors Factor model (abundant factor wins, scarce loses) Sector model (both factors in an abundant- factor-sector win; both factors in a scarce- factor-sector lose) What do we about losers? –Institutions matter!
Take homes Trade is “efficient” But there are winners & losers –Globalization winners – factor model: Abundant factor –Globalization losers – factor model: Scarce factor –Globalization winners – sector model: Export-oriented sector –Globalization losers – sector model: Import-competing sector Political institutions may influence how we deal with losers Factors, Sectors, Institutions
When the US opens up to trade, they move from producing at EaA to PtA. So they shift from shoes to computers. Who gains? –Capital Who loses? –Labor
When the US opens up to trade, they move from producing at EaB to PtB. So they shift from computers to shoes. Who gains? –Labor Who loses? –Capital
Rogowski, Ronald. 1987. Political Cleavages and Changing Exposure to Trade. American Political Science Review 81 (4):1121-1137. 3 factors: land-labor-capital –Considers the land-labor ratio –High land-labor ratio land-abundant, labor-scarce –Low land-labor ratio labor-abundant, land-scarce –Define “advanced” economies as capital-abundant
Pro-trade Anti-trade Pro-trade Anti-trade Pro-trade Anti-trade Pro-trade Anti-trade URBAN-RURAL CONFLICT CLASS CONFLICT Examples: Peron in Argentina, Vargas in Brazil