ECON2915 Economic Growth Lecture 10 : Specific Factors. Andreas Moxnes University of Oslo Fall 2016 1 / 34
Introduction Recall, in Ricardian model: Two products (e.g. rice and cocoa) and one input (labor). Trade occurs because of relative productivity differences across countries − → comparative advantage. In this and the next lecture, we will extend the model to allow for Many inputs (e.g. labor & capital, or skilled & unskilled labor). Enables us to analyze who gains/loses from trade. Some groups may lose even if trade gives GDP growth in the aggregate. 2 / 34
Specific factors model Specific factors model: Two products and two inputs (e.g. labor and capital). One or both of the inputs cannot move across sectors. ◮ Both: Pure specific factors model. ◮ One: Mixed specific factors model (Ricardo-Viner model). How can factors be specific to the industry? Short-run focus. Barriers to mobility (geographic, technological, regulatory..). We’ll focus on the long run next week: The Hecksher-Ohlin model. 3 / 34
Case study Case study: 1828 US tariff bill. US industrial structure in early 1800s: North: Early manufacturing, e.g. cotton textiles South: Food, cotton, tobacco. Rapid manufacturing growth in the North because: Tariffs. War-related interruptions in imports (including embargo of 1807-8). Growth heavily concentrated in New England. 4 / 34
A New England textile mill, 1819 5 / 34
Protectionism in the North Rising industrial sector in New England led to an interest group seeking protection from imports. First tariffs: 1789: 5% ad valorem tariff on most imports. Several increases in tariff: 1816, 1820, 1824, 1828. 1816: 25% ad valorem tariff on cotton textiles. 6 / 34
How about the South? South generally opposed import tariffs. Economy was based on export crops; no manufacturing to speak of. Constitutional convention: 1787: Southern delegates wanted a ban on import tariffs and export taxes. ◮ Settled for ban on export taxes. 7 / 34
Tariff bill of 1828 Unprecedented high tariffs. Average above 50%. North voted for. South vote against. West voted for. Southern politicians denounced the bill as an ‘abomination.’ 8 / 34
Average US tariffs 1790-1836 9 / 34
The economics Clearly a comparative-advantage economy. Exports of cotton and tobacco. Imports of manufactures (such as textiles and apparel). But in a Ricardian-type economy there’d be no conflict over trade policy. Conflict can be understood as a result of specific factors. ◮ Specific factors in North (manufacturing) gain from tariff. ◮ Specific factors in South (agriculture) loses from tariff. 10 / 34
A pure specific-factors model Two goods: ◮ Cotton textiles (aka cloth, C ). Produced in North. ◮ Tobacco, T . Produced in South. Cotton textiles requires L and K . Tobacco requires L and A (acres of land). Capital and manufacturing labor are specific to C ; Land and agricultural labor are specific to T . Assume that cotton textiles are imported, tobacco exported. 11 / 34
Equilibrium North: L N workers, K N units of capital. Perfect competition, so nominal wages equal to the value of the marginal product of labor: w C = p C MPL C � � L C / K . → factor prices will adjust so that demand for labor and capital − equals (the fixed) supply. Similar for the price of capital services: r C = p C MPK C � � L C / K . 12 / 34
The impact of a tariff : North Assume that the US market is relatively small, so that p C and p T are determined on world markets. Then a 50% tariff on C will increase p C by 50%. Both w C and r C increase by 50% when p C increases by 50%. Therefore, both workers and capitalists in the North benefit from the tariff. 13 / 34
The impact of a tariff : South In South, the following must hold: w T = p T MPL T � � L T / A r T = p T MPK T � � L T / A Neither w T and r T increases because of the tariff, since p T is unchanged. Why is p T unchanged? Therefore, Southern factors’ nominal incomes are unchanged, even as the price of cloth goes up. Real incomes of owners of Southern factors fall due to the tariff. 14 / 34
An unrealistic feature of the model When tariff goes up, what happens to the allocation of labor to the cloth industry? 15 / 34
An unrealistic feature of the model When tariff goes up, what happens to the allocation of labor to the cloth industry? Nothing. Therefore, what happens to output in the cloth industry? 15 / 34
An unrealistic feature of the model When tariff goes up, what happens to the allocation of labor to the cloth industry? Nothing. Therefore, what happens to output in the cloth industry? Nothing. 15 / 34
The Ricardo-Viner model Assume labor mobile, capital/land fixed. ◮ We must have a single wage w for the whole country. ◮ r C and r T still different. Equilibrium : Cloth manufacturers will hire until: p C MPL C � � L C / K = w Tobacco growers will hire until: p T MPL T � � L T / A = w At the common value of the wage, labor demand from both sectors must sum to the total supply, L = L C + L T . 3 equations and 3 unknowns ( w , L C and L T ). 16 / 34
Equilibrium 17 / 34
Capital income Area under p C MPL C curve equals p C Q C . Subtract wage bill, wL C , to get income to Northern capitalists. 18 / 34
Effect of the tariff Shifts the p C MPL C curve up everywhere proportionally (by 50%). Wage w goes up. L C goes up, L T goes down. Output Q C goes up, Q T goes down. 19 / 34
Winners and losers 20 / 34
Winners and losers Cloths: Workers & capitalists gain nominally. Tobacco: Workers gain, land owners lose, nominally. 20 / 34
Does the wage go up more or less than 50%? Suppose w increased by 50%. This would put it at point B. But the equilibrium is down and to the right compared to B. Therefore, wage goes up by less than 50%. In other words, w has increased because of the tariff; but w / p C has fallen because of the tariff. ◮ This is the cloth intercept of the workers’ budget line (next slide). Since p T is unchanged, w / p T has risen due to the tariff. ◮ This is the tobacco intercept of the workers’ budget line (next slide). 21 / 34
Budgetline workers 22 / 34
Income of Northern capitalists Recall that r C = p C MPK C � � L C / K . ↑ , hence r C up by more We have p C ↑ by 50% and MPK C � L C / K � than 50%. Real capital income r C K / p C and r C K / p T also rises. 23 / 34
Budgetline capitalists North 24 / 34
Income of Southern landowners Recall that r T = p T MPK T � � L T / A . We have p T unchanged and MPK T � L T / A � ↓ , hence r T ↓ . Real capital income r T A / p C and r T A / p T also ↓ . Budget line shifts in. 25 / 34
Budgetline landowners South 26 / 34
Summing up Factors specific to the export sector are unambiguously hurt by the tariff. Factors specific to the import-competing sector unambiguously benefit from the tariff. Mobile factors (labor) could go either way. ◮ Doesn’t matter what a mobile worker does or where he/she is: ◮ Effect of tariff will be the same. 27 / 34
Case study II Assume two sectors in Norway, potato and salmon farming. Comparative advantage in salmon. Ricardo-Viner model with two inputs, capital and labor. Capital is specific to the sector. Tariffs: 28 / 34
Case study II Analyze the impact of the tariff on... Prices. Employment and output in the two sectors. Nominal wage and nominal capital income. Real wage and real capital income. 29 / 34
A full trade model Introduce a second country, Europe. ◮ Europe similar to the US, except Europe is less productive in tobacco growing: MPL T US > MPL T Europe Drop the small economy assumption − → prices endogenous. 30 / 34
The RS curve As before, wages equals the marginal product of labor in each sector, so � L C � L T � � p C MPL C = p T MPL T K A pins down wages w , L C and L T in each country. This must mean that L C / L T is (an increasing) function of p C / p T . This must mean that Q C / Q T is (an increasing) function of p C / p T − → RS curve. 31 / 34
The RS curve 32 / 34
Autarky and trade Autarky: ◮ Europe RS curve to the right of US RS curve. → p C / p T lower in Europe. ◮ Identical RD curve − Trade: ◮ p C / p T must rise in Europe. ◮ Supply>Demand − → Exports of C from Europe. 33 / 34
Aggregate welfare : Europe A: Autarky production & consumption. Budget line (slope p C / p T ) is tangent to PPF and indiff curve. B: Trade production. Consumption? 34 / 34
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