International Trade: Theory and Evidence • Growth in world exports: 1960–68 7.3% 1968–73 9.7% 1973–80 3.3% 1980–85 2.3% 1985–90 4.5% 1990–03 6.0% • LDC export growth: → rapid in Asia , → highly variable in Latin America , → slow in Africa. ,
- 10 - Figure 1. Growth of Merchandise Exports, 1970-2000 1 2600 2100 Other Developing Countries index (1980=100) 1600 World 1100 600 Sub-Saharan Africa Least Developed Countries 100 1970 1975 1980 1985 1990 1995 2000 Source: IMF World Economic Outlook (WEO). 1 Excluding oil exports. Figure 2. Developing Countries: Share of Exports Going to Other Developing Countries, 1965-98 45 Minerals 40 Agriculture Manufactures 35 Total 30 percent 25 20 15 10 5 0 1965 1970 1975 1980 1985 1990 1995 1998 Source: Global Trade Analysis Project (GTAP) database, version 5. Figure 3. World: Product Composition of Merchandise Exports, 1965-98 100 Minerals 90 80 Agriculture 70 60 percent 50 Manufactures 40 30 20 10 0 1965 1970 1975 1980 1985 1990 1995 1998 Source: GTAP database, version 5.
• Developing countries’ share of world trade: → 20% in 1980 , → 30% in 2005. , → BUT decline in share of sub–saharan Africa (1% → 0.5%) , • Composition of LDC exports has shifted towards manufacturing → now about 70% of total exports , → mostly due to East Asia (esp. China) , → often a result of deliberate policies ,
Figure 4. Developing Countries: Composition of Merchandise Exports, 1965-98 100 90 80 Minerals 70 60 percent 50 40 Agriculture 30 20 Manufactures 10 0 1965 1970 1975 1980 1985 1990 1995 1998 Source: GTAP database, version 5. Figure 5. Share of Commerical Services in Total Exports of Goods and Services,
Figure 6. Sub-Saharan Africa: Composition of Merchandise Exports, 1965-95 100 90 80 70 Minerals 60 percent 50 40 30 Agriculture 20 10 Manufactures 0 1965 1970 1975 1980 1985 1990 1995 Source: GTAP database, version 5.
• Standard hypothesis of trade patterns: Primary goods ¿ DCs LDCs Manufactures → LDCs export proportionately more primary goods , → BUT developed countries do not import proportionately more primary , goods Why ? → large fraction of DC trade is within DCs and is in manufactured goods ,
• Actual World trade ß ows Manufactures DCs DCs ¿ Primary ↑↓ Manu. Primary ↑↓ Manu. LDCs ∼ LDCs • However, trade between LDCs has increased recently to about 10% of world trade
Why Do Countries Trade ? 1. Comparative Advantage — Ricardian Trade Theory Example: → 2 countries: N orth and S outh , → 2 goods: C omputers and R ice , → 1 factor: labour – 600 workers each ,
Technological assumptions: Labour One One sack Required Computer of Rice in North 10 15 in South 40 20 → North has an absolute advantage in both goods, , → but a comparative advantage in computers. , → South has a comparative advantage in rice. ,
Production possibilities frontier • In North: 10 C N + 15 R N = 600 → can be written as , R N = 40 − 2 3 C N • In South 40 C S + 20 R S = 600 → can be written as , R S = 30 − 2 C S
Rice Rice North 40 South 30 2/3 2 0 60 15 Computers Computers 1.Production Possibilities
Autarky • If both goods are consumed in North: p N = 10 15 = 2 c 3 . p N r Why? → Competition ⇒ , p N and p N c = 10 w c r = 15 w r If p N 10 > p N 15 , then w c > w r c r → all workers fl ow into computers. ,
If p N 10 < p N 15 , then w c < w r c r → all workers fl ow into rice , For both goods to be produced, we need w c = w r • Similarly, if both goods are consumed in South: p S = 40 c 20 = 2 . p S r
Free Trade • If both goods are going to be produced: 2 3 < p c < 2 . p r Why ? if p c p r < 2 3 < 2 , both countries specialize in rice if p c p r > 2 > 2 3 , both countries specialize in computers 3 < p c if 2 p r < 2 , → North specializes in computers , → South specializes in rice. ,
• If it is cheaper to produce rice in North, why don’t people buy rice there? → market wages adjust so that rice is not cheaper in the North. , → as we move from autarky to free trade , p N p N c ↑ r ↓ p S p S c ↓ r ↑ so that North : p N 10 = w N > p N c r 15 ⇒ specialize in C South : p S 40 < w S = p S c r 20 ⇒ specialize in C → effectively nulli fi es S’s advantage in rice production. ,
Predictions of Ricardian Theory • Each country specializes in the production of the goods in which it has a comparative advantage and exports them in return for other goods. • All households in both countries are unambiguously better off with free trade than in autarky. → the wage in both countries rises , → consumption possibilities lie outside the production possibilities frontier , Caveats • only one factor of production • labour is perfectly mobile across sectors • competitive markets
Rice Rice North South p c /p r Consumption Consumption X Production M p c /p r 0 Computers M Computers X 2.Gains From Trade
2. Factor Endowments — Neoclassical Trade Theory (Eli Heckscher and Bertil Ohlin) Example → 2 countries: N orth and S outh , → 2 goods: C ars and T extiles , → 2 factors: Capital ( K ) and Labour ( L ) , → identical preferences across countries , • North is relatively well endowed with K : K N L N > K S L S
• Car production is capital intensive and textile production is labour intensive . → given the same w/r . production isoquants are such that K/L for cars , exceeds textiles Capital K c / L c Cars K T / L T Textiles w/r Labour isocost line 3.Capital Intensity
0 T C B Capital A 0 C Labour 4.Edgeworth box for North
Textiles A B C Cars 5.Production Possibilities Frontier for North
0 T F E Capital D 0 C Labour 6.Edgeworth Box for South
Textiles D E F Cars 7.PPF for South
N N p C /p T Textiles C Excess Demand P Cars Excess Supply 8.Disequilibrium in Autarky
Textiles E T* N N p C /p T Cars C * 9.Equilibrium under Autarky
S S p C /p T N N p C /p T 10.Autarky in North and South
North p C /p T p C /p T South C N P N X M C S P N X M 11.Free Trade Equilibrium
Implications of Neoclassical Trade Theory • Under free trade the price ratio settles at a level between the two autarkic price ratios • Incomplete specialization — both countries produce both goods • A country will tend to export the commodities that are intensive in factors that are possessed by that country in relative abundance. → consistent with the “standard hypothsis” of DC–LDC trade, , → does not explain trade fl ows amongst OECD countries , → model predicts a lot of trade between DCs and LDCs , • Households in both countries are potentially better off with free trade BUT there are distributional consequences
3. Differences in Preferences • How do preferences differ between LDCs and DCs ? → one hypothesis: DCs spend proportionately more on manufactured , goods (luxuries) → drives down relative price of primary goods as DCs get richer ,
Textiles Textiles p C /p T M X p C /p T Cars Cars X M 12.Trade due to differences in preferences
4. Economies of Scale • Trade allows concentration of production in some coutries to maximize the effects of economies of scale Example: → 2 identical countries — East and West , → 2 goods — ships and aircraft ,
$ $ Autarky AC AC C A B D Aircraft Ships 13.Trade and Specialization with Economies of Scale
The Gains and Losses from Trade Distributional Consequences of Trade • Neoclassical theory ⇒ potential gains due to increased goods/services BUT not necessarily actual gains to all members of society. Example (from earlier): Move toward free trade in North → increased (capital–intensive) car production , → reduced (labour–intensive) textile production , ⇒ w/r falls → i.e. labour loses, capital gains , • Distribution of gains depends on distribution of factor ownership
Static vs. Dynamic Gains/Losses from Trade • Comparative advantage is a static concept → but technologies and factor endowments change over time , • LDCs could allow trade patterns to change as they accumulate physical / human capital → “natural” shift from primary to manufacturing , BUT may get stuck as primary producer and never invest enough to get beyond this stage
Why ? — Prebisch–Singer Hypothesis → as world gets richer, fraction of income spent on primary products , declines → long–term deterioration in the terms of trade faced by many LDCs: , T.o.T. = Export Price Index Import Price Index ⇒ real incomes grow less rapidly → less capital accumulation / infrastructure , • Policy implication: need to protect / promote domestic manufacturing → may lower current income by distorting the gains from trade , → but this is an “investment” which will raise future incomes. ,
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