McGraw-Hill/Irwin Copyright  2009 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5: Who Gains and Who Loses from Trade?

5-2 Within a country SR effects of opening trade SR effects of opening trade The US - exports wheat (price of wheat increases compared to pre-trade levels) The US - exports wheat (price of wheat increases compared to pre-trade levels) US winners: landlords in wheat production, wheat farm workers US winners: landlords in wheat production, wheat farm workers US losers: cloth workers, US losers: cloth workers, landlords in cotton landlords in cotton ROW – exports cloth (price increases) ROW – exports cloth (price increases) ROW winners: cloth workers, landlords in cotton and wool production ROW winners: cloth workers, landlords in cotton and wool production ROW losers: landlords in wheat production, wheat farm workers ROW losers: landlords in wheat production, wheat farm workers

5-3 LR factor-price response – factors move between sectors in search of higher returns (income gaps in SR) LR factor-price response – factors move between sectors in search of higher returns (income gaps in SR) In the US… In the US… Some US cloth workers will find jobs in wheat production Some US cloth workers will find jobs in wheat production Wages in wheat production will decline after the SR increase (how much?) Wages in wheat production will decline after the SR increase (how much?) Wages in cloth production will increase after the initial decrease Wages in cloth production will increase after the initial decrease Some land will be used for wheat instead of cotton and wool Some land will be used for wheat instead of cotton and wool Rents on land used for wheat will decline after the initial increase Rents on land used for wheat will decline after the initial increase Rents on land used for cotton will increase after the initial decline Rents on land used for cotton will increase after the initial decline

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5-5 Will wages and rents go back to their pre-trade levels after the LR adjustment? Will wages and rents go back to their pre-trade levels after the LR adjustment? No! No! LR winners: US landowners and foreign workers LR winners: US landowners and foreign workers The price of land stays above pre-trade levels in US The price of land stays above pre-trade levels in US The price of labour remains above pre-trade levels in ROW The price of labour remains above pre-trade levels in ROW LR losers: US workers and foreign landowners LR losers: US workers and foreign landowners Reason: wheat is more land intensive and cloth is more labour intensive Reason: wheat is more land intensive and cloth is more labour intensive

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5-7 Implications of the H-O theory The Stolper-Samuelson Theorem The Stolper-Samuelson Theorem Trade changes product prices – wheat has a higher relative price than pre-trade in US Trade changes product prices – wheat has a higher relative price than pre-trade in US Real return to the factor used intensively in the rising- price industry rises (land in wheat production in the US) Real return to the factor used intensively in the rising- price industry rises (land in wheat production in the US) The real return to the factor used intensely in the falling-price industry falls (labour in cloth production in the US) The real return to the factor used intensely in the falling-price industry falls (labour in cloth production in the US) This does not depend on how much of each product is consumed This does not depend on how much of each product is consumed

5-8 The specialized-factor pattern The specialized-factor pattern The more a factor is specialized, or concentrated, in the production of a product whose relative price is rising, the more this factor stands to gain from a change in the product price The more a factor is specialized, or concentrated, in the production of a product whose relative price is rising, the more this factor stands to gain from a change in the product price The more a factor is concentrated into the production of a product whose relative price is falling, the more it stands to lose from the change in the product price The more a factor is concentrated into the production of a product whose relative price is falling, the more it stands to lose from the change in the product price

5-9 The factor price equalization theorem The factor price equalization theorem With time not only product prices equalize, but also factor prices (even if factors don’t move across countries) With time not only product prices equalize, but also factor prices (even if factors don’t move across countries) Workers earn the same wage rate in both countries Workers earn the same wage rate in both countries Pre-trade wages in US are higher due to scarcity Pre-trade wages in US are higher due to scarcity After trade wages decline After trade wages decline Pre-trade wages are lower in ROW (abundant) Pre-trade wages are lower in ROW (abundant) After-trade wages are higher (cloth-export) After-trade wages are higher (cloth-export) Land earns the same return in both countries Land earns the same return in both countries

5-10 International Factor Price Equalization With the shift to free trade: For each factor, its rate of return becomes more similar between countries. Under ideal conditions, its real rate of return is the same in different countries. With the shift to free trade: For each factor, its rate of return becomes more similar between countries. Under ideal conditions, its real rate of return is the same in different countries. Example: Labor. Example: Labor. With no trade, the wage rate is high in the labor-scarce country. The wage rate is low in the labor-abundant country. With no trade, the wage rate is high in the labor-scarce country. The wage rate is low in the labor-abundant country. With free trade, the import of labor-intensive products pushes the wage-rate down in the labor-scarce country. The export of labor-intensive products pulls the wage rate up in the labor- abundant country. With free trade, the import of labor-intensive products pushes the wage-rate down in the labor-scarce country. The export of labor-intensive products pulls the wage rate up in the labor- abundant country.

5-11 H-O and actual trade patterns Factor endowments see table Factor endowments see table International trade – see table International trade – see table

5-12 Figure Shares of the World’s Factor Endowments, Early 2000s

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5-14 Export-oriented and import- competing factors The US pattern – see table The US pattern – see table The Canadian pattern –see table The Canadian pattern –see table

5-15 Figure 5.5 – A Schematic View of the Factor Content of U.S. Exports and Competing Imports

5-16 Figure The Factor Content of Canada’s Exports and Competing Imports

5-17 Do factor prices equalize internationally?? The strong form of theorem is subject to many assumptions and conditions The strong form of theorem is subject to many assumptions and conditions A weak form of the theorem – tendency of factor prices towards equalization A weak form of the theorem – tendency of factor prices towards equalization

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5-21 International Factor Price Equalization With the shift to free trade: For each factor, its rate of return becomes more similar between countries. Under ideal conditions, its real rate of return is the same in different countries. With the shift to free trade: For each factor, its rate of return becomes more similar between countries. Under ideal conditions, its real rate of return is the same in different countries. Example: Labor. Example: Labor.  With no trade, the wage rate is high in the labor- scarce country. The wage rate is low in the labor- abundant country.  With free trade, the import of labor-intensive products pushes the wage rate down in the labor- scarce country. The export of labor-intensive products pulls the wage rate up in the labor- abundant country.

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