McGraw-Hill/Irwin © 2012 The McGraw-Hill Companies, All Rights Reserved Chapter 7: Growth and Trade

This chapter has two major objectives. It shows how the Heckscher-Ohlin model can be used to analyze economic growth and its impact on international trade. It examines additional aspects of technological progress and its relationship to international trade.

Growth in a country's production capabilities shifts the country's production possibilities curve out. Growth is balanced if the PPC shifts out proportionately. Balanced growth could occur because all factors are growing at similar rates, or because production technology is improving at the same rate in both sectors.

Growth is biased (unbalanced) if the outward shift in the PPC is skewed, so that the growth favors producing more of one product than the other. Biased growth could occur if one factor is growing more quickly than the other, or if production technology is improving more in one sector than the other.

Copyright  2012 by The McGraw-Hill Companies, Inc. All rights reserved. 7-5 Figure 7.1 Balanced and Biased Growth

One example of very biased growth is growth in only one factor, the other factor unchanged. While the entire PPC shifts out, the growth is strongly biased in favor of the product that uses the growing factor intensively.

Copyright  2012 by The McGraw-Hill Companies, Inc. All rights reserved. 7-7 Exports Plus Imports as a Percentage of GDP Figure 7.2 Single-Factor Growth: The Rybczynski Theorem

 The Rybczynski theorem indicates that, if product prices are constant, then the output quantity of the product that uses the growing factor intensively will increase, while the output quantity of the other product must contract.  The reason is that expanding production of the intensive good also requires some of the other factor. This amount of the other factor must be drawn from the other industry, so its output declines (the concept of the “Dutch disease”).

Growth that is balanced or biased toward producing the exportable product is likely to increase the country's willingness to trade. Growth that is sufficiently biased toward producing more of the importable product will reduce the country's willingness to trade.

If the country is a large country, then changes in its willingness to trade change the equilibrium international price ratio. If the growth reduces the country's willingness to trade, then the reduced supply of exports and the reduced demand for imports results in an increase in the equilibrium relative price of the country's exportable product. The well-being of the country increases for two reasons—the country's production capabilities increase, and its terms of trade improve.

Copyright  2012 by The McGraw-Hill Companies, Inc. All rights reserved Figure 7.3 Growth Biased Toward Replacing Imports in a Large Country

 If growth increases the willingness to trade of a large country, then the increased supply of exports and the increased demand for imports results in a decrease in the equilibrium relative price of the country's exportable product.  If the price does not change by too much, then the country's well-being is higher—but the increase in well-being is less than it would be if the country's terms of trade did not deteriorate.

 If the price ratio changes by a lot then immiserizing growth is possible—growth that expands the country's willingness to trade causes such a large decline in the country's terms of trade that the well-being of the country declines.  The loss from the decline in the terms of trade is larger than the gain from the larger production capabilities. This is more likely if the growth is strongly biased toward producing more of the exportable product, foreign demand for the country's exports is price inelastic, and the country is heavily engaged in international trade.

Copyright  2012 by The McGraw-Hill Companies, Inc. All rights reserved Figure 2.2 The Market for Motorbikes: Demand and Supply Figure 7.4 Immiserizing Growth in a Large Country

 Openness to international trade can also increase a country’s growth rate.  Imports can speed diffusion of new production technology into a country, through imports of advanced capital goods and, more generally, through greater awareness of new foreign technology.  Openness to trade can also place additional competitive pressure on domestic firms to develop and adopt new technology, and export sales can increase the returns to their R&D activities.  According to the “new growth theory,” these increases in the country’s current technology base can enhance ongoing innovation, resulting in a higher ongoing growth rate.