TECHNOLOGY, GEOGRAPHY, AND TRADE BY JONATHAN EATON AND SAMUEL KORTUM ECONOMETRICA, 2002 Elisa Katharina Orthofer February 4 th, 2016

 Introduction  Literature Review  Stylized Facts  Motivation  The Model/Methodology and Data  Counterfactuals  Conclusion OUTLINE

 Ricardian Model of Comparative Advantage – early 19 th century  H-O Model (Factor Proportions) – 1920s  Dornbusch, Fischer, & Samuelson (1977): “Comparative Advantage, Trade and Payments in a Ricardian Model with a Continuum of Goods”  Eaton & Kortum (2002): “Technology, Geography, and Trade” LITERATURE REVIEW

Assumptions:  2 countries, 2 final goods  Labor as sole input in production  Technologies differ between 2 countries  Perfect competition  No transaction costs THE RICARDIAN MODEL

 Absolute vs. Comparative advantage (CA)  CA: Country exports good in which it has the lower relative OC  CA may create gains from trade  Ricardian Model not used for analysis of trade flows anymore since it ignores crucial aspects such as  Multiple countries and goods  Trade in intermediates  Geographic barriers THE RICARDIAN MODEL

Concerning geography:  Trade diminishes dramatically with distance  Prices vary across locations Concerning technology:  Factor rewards far from equal across countries  Countries’ relative productivities vary significantly across industries STYLIZED FACTS

 First pair suggest geography matters  Last pair suggest technologies differ  Eaton-Kortum (E-K) propose Ricardian model (based on differences in technologies) with geographic barriers to capture all four facts  Model captures tension between comparative advantage and geographic barriers MOTIVATION

 Two-country D-F-S-model with continuum of goods extended to model with many countries  E-K use a probabilistic formulation of productivity differences  Show how model links bilateral trade flows to geography and prices  Trade data in manufacturers among 19 OECD countries in 1990  Finally perform counterfactual exercises METHODOLOGY AND DATA

 Differential access to technology  Efficiency varies across commodities and countries  Cost of bundle on inputs the same across commodities within a country  Constant returns to scale  Presence of geographic barriers (natural and artificial)  Perfect competition ASSUMPTIONS OF THE MODEL

THE MODEL

 Delivering unit of good j produced in i to country n:  Perfect competition implies:   N…# of countries  Buyers purchase individual goods in amounts Q(j) to maximize utility THE MODEL

 E-K assume that country i’s efficiency in producing j is the realization of a random variable Z drawn independently for each j (remember: z i (j)…efficiency)  cost of purchasing particular good from country i in country n is the realization of random variable P ni = c i d ni /Z i  π ni … probability that i’s price for some good the lowest  Efficiency distribution: Fi (z) = Pr[Z ≤ z] TECHNOLOGY

 T i …state of technology  Reflects countries’ absolute advantage  Bigger T implies that high efficiency draw for any good j more likely  Θ…technology heterogeneity  Lower Θ implies more variability, so more heterogeneity: comparative advantage exerts stronger force over geographic barriers TECHNOLOGY

 Ф…price parameter that summarizes how  States of technology  Input costs  Geographic barriers determine prices in each country  Two extremes:  Zero-gravity (d ni = 1 for all n and i), ф same everywhere  Autarky (d ni  ∞) PRICES

 X ni /X n …fraction of n’s expenditure on goods from country i  Importer’s total purchases X ni  Exporter’s total sales Q i TRADE FLOWS AND GRAVITY

 Model implies connection between trade flows and prices differences  Country i’s share in country n relative to i’s share at home (normalized import share):  As comparative advantage weakens, normalized import shares become more elastic  Measured with data on bilateral trade in manufactures (342 observations) TRADE, GEOGRAPHY, AND PRICES

TRADE AND GEOGRAPHY

TRADE AND PRICES

3 equations that represent full general equilibrium: 1. Price level 2. Trade shares EQUILIBRIUM

3. Wages  L i …number of manufacturing workers in i  α…fraction spent on manufacturers  β…constant labor-inputs ratio/labor share in costs EQUILIBRIUM

 Gains from trade in manufacturers: small countries gain more  How technology and geography determine patterns of specialization: smaller countries benefit  Role of trade in spreading benefits of new technology: distance is crucial  Consequences of tariff reductions COUNTERFACTUALS

 E-K raise geographic barriers first to autarky, then to zero-gravity level  Costs of moving to autarky < gains of zero-gravity  Manufacturing employment shrinks in the four natural manufacturers (GER, JP, SE, UK), indicating comparative advantage in manufactures  Smaller countries gain more GAINS FROM TRADE

 In the case of mobile labor, geography is irrelevant for determining labor force in manufacturing  Two basic patterns:  As geographic barriers start falling, manufacturing ↘ for smaller countries and ↗ for larger countries (cheaper inputs)  As barriers keep falling, pattern reverses and forces of technology take over  Example: Denmark and Germany TECHNOLOGY VS. GEOGRAPHY

 Effects on welfare following increase of technology by 20 % (US, GER)  Other countries always gain through lower prices  Overall welfare effect generally lower when countries can’t downsize manufacturing labor force  The closer a country is to the source of advance, the higher its benefit BENEFITS OF FOREIGN TECHNOLOGY

 Welfare rises almost everywhere with collective removal of tariffs  If US remove tariffs unilaterally, everyone benefits except the US  Eliminating tariffs within 1990 EC: gains and losses mainly depend on labor mobility  Labor immobility: main losers are nonmembers  Labor mobility: main losers Northern EC members ELIMINATING TARIFFS

 Comparative advantage creates potential gains from trade  Extent of gains limited by geographic barriers  Trade allows country to benefit from foreign technological advances  Country must be near the source of advance  Possibility of reallocating its labor outside manufacturing CONCLUSION