Relationship between international factors movement and international trade

Substitution Assume labor moves from china into U.S. After the immigration, China will produce less labor-intensive products while the US will produce more labor-intensive commodities. This implies that international trade between the two countries will shrink.

Mundell (1959,AER) Model Assumptions: 2 by 2 model Produce steel and cotton China is labor abundant but small country US is capital abundant and large country Identical technology Factors are perfectly mobile between the two countries.

Assume factors are perfectly immobile first, but we allow free trade. If China imposes a high import tariff on steel, then what happens to the interest rate which is the return on the capital?

china C p’ P D Y

Recall Stolper-Samuleson Theorem An increase of the relative price of a commodity will increase the real return of the factor used intensively in that product. Price of steel up  r up An increase of price of the steel  steel production raises  require more capital  excess demand exists  pushes up capital price.

Rch > Rus Capital flows into China China’s PPF outshifts Capital outflow does not affect US’s MPK. Eventually, China’s MPK should equal US’s MPK China’s final relative price ratio should be identical to its original price ratio.

Production in China increases, but welfare is still the same since we have to pay the interest to the foreign country. Hence, they exist a substitute relationship between factor movement and international trade. Markuson (1983) : international factor movement and trade are complement instead of substitution by assuming heterogeneous technology across countries !