1. International Economics Tenth Edition
CHAPTER S E V E N 7
International Economics Tenth Edition
Economic Growth and
International Trade
Dominick Salvatore
John Wiley & Sons, Inc.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

2. Learning Goals:
Explain how the change in a nation’s factor endowments affects its growth, terms of trade, volume of trade, and welfare.
Explain how technological change affects growth, trade, and welfare.
Explain how a change in tastes affects growth, trade, and welfare.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

3. Most trade theory discussed so far is static in nature.
Introduction
Most trade theory discussed so far is static in nature.
However, factor endowments, technology and tastes can change over time, changing a nation’s comparative advantage.
Changes in factor endowments, technology and tastes affect a nation’s production frontier, offer curve, volume and terms of trade, and gains from trade.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

4. Growth of Factors of Production
Increases in labor (L) and capital (K) shift the production frontier outward. Type and degree of shift depend on rate of growth:
Balanced growth is when L and K grow at the same rate, shifting frontier out evenly in all directions.
Slope on each frontier are equal where cut by a ray from the origin.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

5. Growth of Factors of Production
Increases in labor (L) and capital (K) shift the production frontier outward. Type and degree of shift depend on rate of growth:
If only L grows, output of both commodities increases.
Output of the L-intensive commodity will increase faster than that of the K-intensive commodity (the opposite is true if only K grows).
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

6. FIGURE 7-1 Growth of Labor and Capital Over Time.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

7. Growth of Factors of Production
The Rybczynski Theorem
At constant commodity prices, an increase in the endowment of one factor will increase by a greater proportion the output of the commodity intensive in that factor and will reduce the output of the other commodity.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

8. Growth of Factors of Production
The Rybczynski Theorem
For example, if only L grows in Nation 1, the output of commodity X (the L-intensive commodity) expands more than proportionately, while the output of commodity Y (the K-intensive commodity) declines at constant PX and PY.
Magnification effect is formally proved in the Appendix.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

9. FIGURE 7-2 The Growth of Labor Only and the
Rybczynski Theorem.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

10. Three different types of Hicksian technical progress:
All technical progress reduces the amount of both labor and capital required to produce any given level of output.
Three different types of Hicksian technical progress:
Neutral – increases productivity of L and K in same proportion, so K/L remains the same after the technical progress as before, at unchanged relative factor prices (w/r).
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

11. Three different types of Hicksian technical progress:
Neutral
Labor-saving – increases productivity of K proportionately more than the productivity of L. SO K is substituted for L in production and K/L rises at unchanged w/r.
Capital-saving – increases productivity of L proportionately more than the productivity of K. So L is substituted for K in production and L/K rises at unchanged w/r
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

12. Technical Progress
The same rate of neutral technical progress in production of both commodities has the same effect on the production frontier as balanced factor growth.
The production frontier will shift out evenly in all directions at the same rate at which technical progress takes place.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

13. FIGURE 7-3 Neutral Technical Progress.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

14. Growth and Trade: The Small-Country Case
A “small country” is too small to affect the relative commodity prices at which it trades (so the nation’s terms of trade remain constant).
Growth is protrade if:
output of a nation’s export commodity grows proportionately more than the output of its import commodity at constant relative commodity prices, leading to greater than proportionate expansion of trade.
Otherwise, growth is antitrade, or neutral.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

15. Growth and Trade: The Small-Country Case
Production is protrade if:
output of a nation’s export commodity grows proportionately more than the output of its import commodity.
Consumption is protrade if:
The nation’s consumption of its import commodity increases proportionately more than consumption of its export commodity.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

16. Growth and Trade: The Small-Country Case
What happens to the volume of trade in the process of growth depends on the net result of production and consumption effects.
Protrade
Antitrade
Neutral
Impact on Trade Volume
Production
Consumption
Trade expands proportionately FASTER than output
Trade expands proportionately LESS than output
Trade growth depends on net effect of opposing forces
Trade expands at same rate as output
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

17. FIGURE 7-4 Factor Growth and Trade: The Small-Country Case.
(Figure continues on next slide)
FIGURE 7-4 Factor Growth and Trade: The Small-Country Case.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

18. FIGURE 7-4 (continued)
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

19. Growth and Trade: The Large-Country Case
A “large country” is sufficiently large to affect the relative commodity prices at which it trades (so the nation’s terms of trade can change).
Terms of trade effect
If growth expands the nation’s volume of trade at constant prices, terms of trade deteriorate.
If growth reduces the nation’s volume of trade at constant prices, terms of trade improve.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

20. Growth and Trade: The Large-Country Case
Wealth effect
Change in output per worker as a result of growth.
Alone, positive welfare effect improves welfare, and vice versa.
Impact on welfare depends on net effect of wealth effect and terms of trade effect:
Wealth Effect
Terms of Trade Effect
Impact on Welfare +
Welfare increases -
Welfare declines
Welfare may, rise, fall or not change, depending on relative strength of opposing effects.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

21. FIGURE 7-5 Growth and Trade: The Large-Country Case.
(Figure continues on next slide)
FIGURE 7-5 Growth and Trade: The Large-Country Case.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

22. FIGURE 7-5 (continued)
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

23. Growth and Trade: The Large-Country Case
Immiserizing Growth
If the wealth effect is positive, but the terms of trade deteriorates so much that the nation’s welfare declines, nation experiences immiserizing growth.
More likely to occur in developing nations, although not prevalent in the real world.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

24. FIGURE 7-6 Immiserizing Growth.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

25. FIGURE 7-7 Growth That Improves Nation 1’s Terms
(Figure continues on next slide)
FIGURE 7-7 Growth That Improves Nation 1’s Terms
of Trade and Welfare.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

26. FIGURE 7-7 (continued)
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

27. Growth, Change in Tastes, and Trade in Both Nations
With balanced growth and neutral technical progress in both commodities in both nations:
Both nations’ offer curves will shift outward and move closer to the axis measuring the nation’s export commodity.
Volume of trade expands, terms of trade either does not change or improve for one nation, and deteriorates for the other.
Depends on the shape of each nation’s offer curve and the degree by which each offer curve rotates.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

28. Growth, Change in Tastes, and Trade in Both Nations
With growth and/or change in tastes in both nations:
Both nations’ offer curves will shift, changing volume and/or terms of trade.
A shift of the offer curve toward the axis measuring the export commodity will increase trade at constant prices and improve terms of trade.
An opposite shift of the offer curve will reduce volume of trade at constant prices and improve terms of trade.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

29. FIGURE 7-8 Growth and Trade in Both Nations.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

30. Case Study 7-1 Growth in the Capital Stock per Worker of Selected Countries
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

31. Case Study 7-2 Growth in Output per Worker from Capital Deepening, Technological Change, and Improvements in Efficiency
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

32. Case Study 7-3 Growth and the Emergence of New Economic Giants
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

33. Case Study 7-4 Growth, Trade, and Welfare in the Leading Industrial Countries
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

34. Graphical Proof of the Rybczynski Theorem
Appendix to Chapter 7
Graphical Proof of the Rybczynski Theorem
Growth with the Specific-Factors Model
Hicksian Neutral, L-Saving, and K-Saving Technical Progress
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

35. FIGURE 7-9 Graphical Proof of the Rybczynski Theorem.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

36. FIGURE 7-10 Growth with the Specific-Factors Model.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

37. FIGURE 7-11 Hicksian Neutral, L-Saving, and K-Saving
Technical Progress.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.

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Case studies and tables.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.