International Trade and Economic Growth Dianna DaSilva- Glasgow

Outline Introduction Growth of factors of production 1/13/2019 Introduction Growth of factors of production Technical progress Growth and trade: the small country case The effect of growth on trade Growth and trade: the large country case Growth, change in Tastes in Both Nations International Trade Theory- ECN 4202, 2016/2017

INTRODUCTION 1/13/2019 How changes in factor endowments affect trade, growth and welfare? How technological change affects trade, growth and welfare? How changes in tastes affect trade, growth and welfare? International Trade Theory- ECN 4202, 2016/2017

INTRODUCTION 1/13/2019 Static vs. Dynamic Comparative Advantage (factor endowments) Comparative Static vs. Dynamic Analysis Comparative statics analyze the effect on the equilibrium position resulting from a change in underlying economic conditions and without regard to the transitional period and process of adjustment. Dynamic analysis deals with the time path and the process of adjustment itself. International Trade Theory- ECN 4202, 2016/2017

INTRODUCTION 1/13/2019 The Heckscher-Ohlin model is an explanation of trade based on given supplies of capital and labour, a given level of technology, and given tastes. As factor supplies change, technology advances, and tastes change, relative prices and comparative advantage may change. International Trade Theory- ECN 4202, 2016/2017

GROWTH OF FACTORS OF PRODUCTION 1/13/2019 Growth in factors of production (L and K) will shift the PPF outward by the rate of growth. Balanced growth – growth in L and K at the same rate. If there are constant returns to scale (output grows at the same rate as factor growth), then all absolute numbers are larger, e.g. more capital, more labour, more production, but by the same proportion. With equi- proportionate increases in K, L, per capita incomes will remain unchanged. In the case of balanced growth, the production possibility frontier shifts out uniformly. The slope will be identical. International Trade Theory- ECN 4202, 2016/2017

GROWTH OF FACTORS OF PRODUCTION 1/13/2019 If one factor increases faster than the other, then absolute and relative numbers change. If only labour grows, output of both commodities will increase but the labour-intensive commodity will increase at a faster rate. With doubling of L the Labour- intensive commodity does not double. Both factors would have to double for X to double. International Trade Theory- ECN 4202, 2016/2017

GROWTH OF FACTORS OF PRODUCTION 1/13/2019 If only capital grows, output of both commodities will increase but the capital-intensive commodity will increase at a faster rate. With doubling of K the capital- intensive commodity does not double. Both factors would have to double for Y to double. International Trade Theory- ECN 4202, 2016/2017

Factor Growth and the ppf 1/13/2019 Balanced growth in L and K (ppfs have identical slopes) International Trade Theory- ECN 4202, 2016/2017

Unbalanced growth: Output of the commodity intensive in the factor experiencing the growth grows more than the other commodity but does not double. 1/13/2019 International Trade Theory- ECN 4202, 2016/2017

GROWTH OF FACTORS OF PRODUCTION 1/13/2019 If capital grows faster than the labour force, then the productivity of labour will increase because each labourer, on average will have more capital with which to work. If productivity increases, then per capita incomes will increase. International Trade Theory- ECN 4202, 2016/2017

GROWTH OF FACTORS OF PRODUCTION 1/13/2019 If labour grows faster than capital, then labour productivity will fall as each labourer has less K to work with (diminishing returns occurs when a variable input is applied to a fixed input. This diminishing returns is due to labour increasing faster than capital increases). As labour productivity falls, then per capita incomes will fall. International Trade Theory- ECN 4202, 2016/2017

Rybczynski theorem 1/13/2019 Growth in one factor leads to a greater proportionate increase in the commodity intensive in that factor and a decline in the other commodity at constant commodity prices. E.g. Doubling of labour more than doubles output of the labour-intensive commodity X and results in the decline in commodity Y because some L and K is transferred to the production of X. International Trade Theory- ECN 4202, 2016/2017

Pre-growth production pt B (130X and 20Y); post- trade production pt M (270X and 10Y) 1/13/2019 International Trade Theory- ECN 4202, 2016/2017

Rybczynski theorem Proof 1/13/2019 Proof Assume that the relative price of goods does not change. If relative prices do not change, then relative factor prices do not change. For a given Px/Py, there is a unique w/r. If the relative factor price (w/r) does not change, then the relative amounts of capital and labour used will not change, (capital- labour ratios remain unchanged in the production of both goods). International Trade Theory- ECN 4202, 2016/2017

Rybczynski theorem 1/13/2019 Now assume an increase in the labour force. In order for the K/L ratio to remain constant in the production of both goods, production of the capital- intensive good must fall, releasing more capital than labour. The released capital and labour can be combined with the new labour to produce the Labour- intensive good. International Trade Theory- ECN 4202, 2016/2017 An increase in the labour force will lower the price of labour. So less will be used which will increase L in the K/L. to keep the ratio the same K will have to increase. Therefore production of the K- intensive commodity will have to fall.

TECHNICAL PROGRESS Definitions from John Hicks: 1/13/2019 Definitions from John Hicks: Neutral technical progress- increases the productivity of L and K in the same proportion such that K/L remains the same at unchanged relative factor prices in the production of both commodities (no substitution of K for L). However, both commodities can now be produced with less K and L. International Trade Theory- ECN 4202, 2016/2017

TECHNICAL PROGRESS 1/13/2019 Labour- saving technical progress- increases the productivity of K proportionately more than L such that K is substituted for L in production and K/L rises in production at unchanged w/r. More K is used per unit of L in production however output is produced with fewer units of L and K with higher K/L International Trade Theory- ECN 4202, 2016/2017

TECHNICAL PROGRESS 1/13/2019 Capital-saving technical progress- increases the productivity of L proportionately more than K such that L is substituted for K in production and L/K rises in production at unchanged w/r. More L is used per unit of K in production however output is produced with fewer units of L and K but with higher L/K. International Trade Theory- ECN 4202, 2016/2017

How does balanced technical progress affect the nation’s ppf? 1/13/2019 Neutral Technical Progress; doubling of productivity in L and K only (dashed line) in the production of either X and Y doubles output. International Trade Theory- ECN 4202, 2016/2017

Growth and trade: The Small Country Case 1/13/2019 A small country faces a constant terms of trade because it is too small to affect the relative commodity prices at which trade occurs. How does factor growth affect welfare? For a nation involved in trade, the effect of factor growth depends on the commodity that experienced the factor growth and the consumption patterns of the country. International Trade Theory- ECN 4202, 2016/2017

Growth and trade: The Small Country Case 1/13/2019 With constant commodity prices growth can have a pro-trade, anti-trade or neutral effect on production: Growth is pro-trade if it leads to a greater proportionate increase in the nation’s exportable commodity relative to its importable commodity at constant commodity prices. Growth is antitrade if it leads to a greater proportionate increase in production of the nation’s importable commodity relative to its exportable at constant commodity prices. Growth is neutral if the increase in production of both commodities is in the same proportion. International Trade Theory- ECN 4202, 2016/2017

Production effect of growth Change in production of exportables Change in production of importables Production effect Larger Smaller Protrade Antitrade Equal Neutral 1/13/2019 International Trade Theory- ECN 4202, 2016/2017

Growth and trade: The Small Country Case 1/13/2019 The consumption effect can be similarly characterized: Consumption is pro-trade if there is a greater proportionate increase in consumption of importables than exportables at constant prices. This will lead to an expansion of trade. Consumption is antitrade if there is a greater proportionate increase in consumption of exportables than importables at constant prices. This will lead to a reduction in trade. International Trade Theory- ECN 4202, 2016/2017

Growth and trade: The Small Country Case 1/13/2019 Consumption is netural if the increase in consumption is in the same proportion for both commodities. International Trade Theory- ECN 4202, 2016/2017

Consumption effect of growth Change in consumption of exportables Change in consumption of importables Consumption effect Smaller Larger Protrade Antitrade Equal Neutral 1/13/2019 International Trade Theory- ECN 4202, 2016/2017

Growth and trade: The Small Country Case 1/13/2019 The ultimate impact on the volume of trade depends on the net effect of the production and consumption impacts. Pro-trade production and consumption means that trade will increase faster than the growth in output. Neutral production and consumption means that trade will grow at the same rate as the growth in output. Anti-trade production and consumption means that trade will reduce faster than the growth in output. International Trade Theory- ECN 4202, 2016/2017

Growth and trade: The Small Country Case 1/13/2019 Summary of Figure 7.4: Growth is pro-trade because commodity X is the commodity of this nation’s comparative advantage and that commodity experienced an increase (production more than doubled with the doubling of L) relative to commodity y (decline) (rybczynski theorem) International Trade Theory- ECN 4202, 2016/2017

Growth and trade: The Small Country Case 1/13/2019 Consumption is pro-trade because consumption of Y increased more than x (ray through point from the origin) Nation’s offer curve shifts outward because more X can be offered for each unit of Y Although trade definitely increased, the impact on the nation’s social welfare is negative since total consumption less than doubled with the doubling of L given unchanged prices. International Trade Theory- ECN 4202, 2016/2017

1/13/2019 Consumption rises with growth (normal goods ) but social welfare declines International Trade Theory- ECN 4202, 2016/2017

Technical Progress, Trade and Welfare 1/13/2019 How does technical (neutral) progress affect trade and welfare? Effect on production and consumption Neutral expansion of consumption and production leads to an expansion of trade in the same rate Neutral production and pro-trade consumption leads to a greater proportionate increase in the volume of trade than the increase in production. Neutral production and anti-trade consumption the volume of trade is less than the growth in production. International Trade Theory- ECN 4202, 2016/2017

Technical Progress, Trade and Welfare 1/13/2019 Neutral technical progress in the exportable commodity only is pro-trade as trade of the exportable commodity expands (production of the importable commodity declines, ppf expands along X axis). The impact on welfare is positive with a constant labour force compared to where only L doubles. Neutral technical progress increases the welfare of the population with constant L. International Trade Theory- ECN 4202, 2016/2017

Technical Progress, Trade and Welfare 1/13/2019 Neutral technical progress only in the production of the importable commodity is anti-trade. PPF expands only the Y- axis (less of X will be produced). With unchanged terms of trade, tastes and prices the volume of trade will decline but national welfare increases. Neutral technical progress (whether at different rates for the two commodities) always improves welfare even though the volume of trade may decline or increase because it improves the productivity of labour. International Trade Theory- ECN 4202, 2016/2017

GROWTH AND TRADE: THE LARGE COUNTRY CASE 1/13/2019 Effect on welfare and trade where the country is sufficiently large as to affect the terms of trade? Terms of trade effect vs. wealth effect. Terms of trade effect of growth: If growth expands the nation’s volume of trade at constant prices then the nation’s terms of trade deteriorates. If growth reduces the nation’s volume of trade at constant prices, the nation’s terms of trade improves International Trade Theory- ECN 4202, 2016/2017

GROWTH AND TRADE: THE LARGE COUNTRY CASE 1/13/2019 Wealth effect Change in the output per worker as a result of growth. Positive wealth effect increases the nation’s welfare. The wealth effect is positive where K increases The wealth effect is negative where L increases. The wealth effect and terms of trade effect together determines the overall impact on the country’s welfare. See figure 7.5 International Trade Theory- ECN 4202, 2016/2017

GROWTH AND TRADE: THE LARGE COUNTRY CASE 1/13/2019 Immiserizing growth – where the decline in the terms of trade is sufficient to reduce the overall impact on welfare even after a positive wealth effect. (See figure 7.6) Immiserizing growth will occur because: Increase in exports at constant terms of trade Large country can affect its terms of trade by increasing output (therefore attempting to expand exports will only deteriorate the terms of trade) Low income elasticity of demand for commodity The nation is heavily dependent on trade so that a substantial deterioration in terms of trade decreases overall welfare.   International Trade Theory- ECN 4202, 2016/2017

GROWTH AND TRADE: THE LARGE COUNTRY CASE 1/13/2019 When does growth benefit trade and welfare? When there is growth in K, the terms of trade effect is positive because the volume of trade reduces at constant prices. The wealth effect is positive because the greater productivity of K can increase output at constant prices and with no change in L and population. Graph 7.7 International Trade Theory- ECN 4202, 2016/2017

GROWTH AND TRADE: THE LARGE COUNTRY CASE 1/13/2019 The difference between a situation where welfare is improved and lowered is the quantity of commodities that the nation produces at constant prices and the nature of the factor growth. L growth lowers the wealth effect because wages are likely to be lower it also lowers the terms of trade effect because output and trade is likely to be higher. K growth increases the wealth effect because L remains unchanged. It also improves the terms of trade effect by lowering the volume of trade. International Trade Theory- ECN 4202, 2016/2017

GROWTH AND TRADE: THE LARGE COUNTRY CASE 1/13/2019 Growth in only one country will deteriorate that country’s terms of trade if growth is in its abundant factor. On the other hand, the terms of trade of the importing country will improve. With growth in both countries in the abundant factor the volume of trade will increase but the terms of trade will remain the same. See figure 7.8 International Trade Theory- ECN 4202, 2016/2017

GROWTH AND TRADE: THE LARGE COUNTRY CASE 1/13/2019 If there is growth in only one country in that country’s scarce factor, its terms of trade will improve because the volume of trade will reduce. Growth in both countries in their scarce factor would reduce the volume of trade but leave the terms of trade unchanged. Balanced growth or neutral technical progress in both commodities will increase the volume of trade but the terms of trade effect depends on the curvature of the offer curves. International Trade Theory- ECN 4202, 2016/2017

CHANGE IN TASTES AND TRADE IN BOTH NATIONS 1/13/2019 An increase in taste for the importable commodity will increase the volume of trade and lower the terms of trade, vice versa. International Trade Theory- ECN 4202, 2016/2017

Further reading Salvatore (2007) , Chapter 7 1/13/2019 International Trade Theory- ECN 4202, 2016/2017