Advanced International Trade - uCoz

1 Advanced International Trade :Theory and Evidence(c) Robert C. FeenstraUniversity of California, Davis, andNational Bureau of Economic ResearchAugust 2002 Contents:Forward1. Preliminaries: Two-Sector Models2. The Heckscher-Ohlin Model3. Many Goods and Factors4. Trade in Intermediate Inputs and Wages5. Increasing Returns and the Gravity Equation6. Gains from Trade and Regional Agreements7. Import Tariffs and Dumping8. Import Quotas and Export Subsidies9. Political Economy of Trade Policy10. Trade and Endogenous Growth11. Multinationals and Organization of the FirmAppendix A. Price, Productivity and Terms of Trade IndexesAppendix B. Discrete Choice ModelsReferences2 ForewordThis book is intended for a graduate coursein International Trade .

2 I assume thatall readers have completed graduate courses in microeconomics and econometrics. Mygoal is to bring the reader from that common point up to the most recent research ininternational Trade : in both theory andempirical work. This is not intended to be adifficult book, and the mathematics used should be accessible to any graduate material covered will give the readerthe skills needed to understand the latestarticles and working papers in the the same time, I am aware that many readers will become teachers in the field,especially at the undergraduate level. I feel that it is suitable, then, to start each chapterby introducing simple graphical techniques that can be used in teaching.

3 Following this, Imove towards the equations for each model. A set of problems at the end of each chaptergive the reader some experience in manipulating these equations. An instructors manualthat accompanies this book provides solutions to the addition, I haveincluded empirical exercises that replicate the results in some chapters. Completing all ofthese could be the topic for a second course, but even in a first course there will be apayoff to trying some exercises. The data and programs for these can be found on word on notation. I consistently usesubscriptsto refer to goods or factors,whereassuperscriptsrefer to consumers or countries. In general, then,subscripts refer tocommodities and superscripts refer to agents.

4 The index used (h, i, j, k,l,m,orn)will1 Faculty wishing to obtain the instructors manual should contact Princeton University programs for the empirical exercises are provided in STATA. Readers not familiar with STATA areencouraged to complete the web course developed by James Levinsohn and available on the context. The symbol c is used for both costs and consumption, though insome chapters I instead use d(p) for consumption to avoid confusion. The output offirms is consistently denoted by y and exports are denoted by x . Upper-case lettersare used in some cases to denote vectors or matrixes, and in other cases to denote thenumber of goods (N), factors (M), households (H) or countries (C), and sporadicallyelsewhere.

5 The symbols and are used generically for intercept and slope coefficients,including fixed and marginal labor contents of several chapters included here have been previously 4 and 5 are revisions from articles appearing in Kwan Choi and James Harrigan,eds.,Handbook of International Trade (Basil Blackwell, 2003) and theScottish Journalof Economics,respectively. Somematerialfromchapters7 9hasappearedinarticlespublished in theJournal of International Economicsand theQuarterly Journal ofEconomics,and material from chapter 10 has appeared in theJournal of DevelopmentEconomicsand theAmerican Economic , Advanced International TradeChapter 1: Preliminaries: Two-Sector ModelsWe begin our study of International Trade with the classic Ricardian model, which hastwo goods and one factor (labor).

6 The Ricardian model introduces us to the idea thattechnological differences across countries matter. In comparison, the Heckscher-Ohlin modeldispenses with the notion of technological differences and instead show howfactor endowmentsform the basis for Trade . While this may be fine in theory, it performs very poorly in practice: aswe show in the next chapter, the Heckscher-Ohlin model is hopelessly inadequate as anexplanation for historical or modern Trade patterns unless we allow for technological differencesacross countries. For this reason, the Ricardian model is as relevant today as it has always treatment of it in this chapter is a simple review of undergraduate material, but we will havethe opportunity to refer to this model again at various places throughout the reviewing the Ricardian model, we turn to the two-good, two-factor model whichoccupies most of this chapter and forms the basis of the Heckscher-Ohlin model.

7 We shallsuppose that the two goods are traded on International markets, but do not allow for anymovements of factors across borders. This reflects the fact that the movement of labor andcapital across countries is often subject to controls at the border and generally much less freethan the movement of goods. Our goal in the next chapter will be to determine the pattern ofinternational Trade between countries. In this chapter, we simplify things by focusing primarilyononecountry, treating world prices as given, and examine the properties of this two-by-twomodel. The student who understands all the properties of this model has already come a longway in his or her study of International , Advanced International Trade1-2 Ricardian ModelIndexing goods by the subscript i, let aidenote the labor needed per unit of production ofeach good at home, while*ia is the labor need per unit of production in the foreign country,i=1,2.

8 The total labor force at home is L and abroad is L*. Labor is perfectly mobile betweenthe industries in each country, but immobile across countries. This means that both goods areproduced in the home country only if the wages earned in the two industries are the same. Sincethe marginal product of labor in each industry is 1/ai, wages are equalized across industries ifand only if p1/a1=p2/a2,wherepiis the price in each industry. Letting p = p1/p2denote therelativeprice of good 1 (using good 2 as the numeraire), this condition is p = a1 results are illustrated in Figure (a) and (b), where we graph the productionpossibility frontiers (PPF s) for the home and foreign countries. With all labor devoted to good iat home, it can produce L/aiunits, i=1,2, so this establishes the intercepts of the PPF, andsimilarly for the foreign country.

9 The slope of the PPF in each country is then a1/a2and*2*1 autarky ( no International Trade ), the equilibrium relative prices paand apmust equalthese slopes in order to have both goods produced in both countries, as argued above. Thus, theautarky equilibrium at home and abroad might occur at points A and A*. Suppose that the homecountry has acomparative advantagein producing good 1, meaning that a1/a2<*2*1 that the home autarky relative price of good 1 islowerthan that letting the two countries engage in International Trade , then what is the equilibriumprice p at which world demand equals world supply? To answer this, it is helpful to graph theFeenstra, Advanced International Trade1-3BB*Figure (a): Home CountryFigure (b): Foreign CountryAL/a1y1y2L/a2 CRelativesupply(L/a1)/(L*/*2a)(y1+*1y)/( y2+*2y)p apppaRelativedemandFigure *L*/*1a*1yC**2yL*/*2apa*pappFeenstra, Advanced International Trade1-4world relative supply and demand curves, as illustrated in Figure For the relative pricesatisfying p < pa=a1/a2andp< ap=*2*1a/a, both countries are fully specialized in good 2(since wages earned in that sector are higher), so the world relative supply of good 1 is zero.

10 Forpa<p< ap, the home country is fully specialized in good 1 whereas the foreign country is stillspecialized in good 2, so that the world relative supply is (L/a1)/(L*/)a*2, as labeled in Finally, for p > paandp> ap, both countries are specialized in good 1. So we see that theworld relative supply curve has a stair-step shape, which reflects the linearity of the PPF obtain world relative demand, let us make the simplifying assumption that tastes areidentical and homothetic across the countries. Then demand will be independent of thedistribution of incomeacrossthe countries. Demand being homothetic means thatrelativedemand d1/d2in either country is a downward-sloping function of the relative price p, asillustrated in Figure In the case we have shown, relative demand intersects relative supply atthe world price p that liesbetweenpaand ap, but this does not need to occur: instead, we canhave relative demand intersect one of the flat-segments of relative supply, so that the equilibriumprice with tradeequalsthe autarky price in one on the case where pa<p< ap, we can go back to the PPF s of each countryand graph the production and consumption points with free Trade .