International Economics: Trade Theory and Policy WS 2013/14 Christen/Leiter/Pfaffermayr Lecture:

International Economics

International Economics:

Trade Theory and Policy

WS 2013/14

Christen/Leiter/Pfaffermayr

Lecture:

Mo. 8:30-11:00, HS3

Proseminar:

see SyllabusPage 1


Literature

van Marrewijk, Ch. (2012), International Economics, Oxford University Press, 2nd ed.

Chapters from Parts I, II and III

Additional material will be covered in the Proseminar

Page 2


Includes all the material covered in the course (lecture plus proseminar).

A positive grade in the PS is a necessity.

Course grade is an ECTS-weighted average of exam and PS.

An example of an exam plus some examples of exam questions are provided in OLAT.

Three final exams per semester.

Lecture: 70.0%Two short essays. You can choose from three topics.

Proseminar: 30.0%Three short questions.

.

Exam and Grading

Page 3

International EconomicsInternational Economics

• Determinants of trade and industry structure of an open

economy in the long run.

• The welfare effects and distributional consequences (factor

incomes) of worldwide globalization and trade liberalization.

• Labor market effects of trade and foreign direct investment.

• Trade Policy:

Instruments and their welfare effects

The impact and the welfare effects of regional trade

agreements

Questions addressed in trade theory and policy I

Page 4


• Structural change and trade liberalization: Should European

countries protect e.g. their textile industries?

• ‘Are our wages set in Beijing?’: The impact of trade with low

wage countries on low skilled workers’ wages in Europe.

• Why do trade volumes grow faster than GDP?

• What can we expect from the multilateral trade liberalization

efforts of WTO?

• The impact of a bilateral Trade Agreements, e.g., between EU

and US?

Questions addressed in trade theory and policy II

Page 5


• Study Guide: Stephan Schueller and Daniel Ottens Oxford

University Press

• Krugman, Paul R., Maurice Obstfeld and Marc J. Melitz:

International Economics, Theory and Policy, Pearson, 9th

ed., 2012.

• Feenstra Robert C. and Alan M. Taylor, International

Economics: International Edition, Worth Publishers, 2nd ed.,

2011

• Further literature cited in these two books, especially papers

in the academic journals

Literature and Resources I

Page 6


FIW: http://www.fiw.ac.at/

WIFO: http://www.wifo.ac.at/

WIIW: http://www.wiiw.ac.at/

WTO: http://www.wto.org/

EU: http://ec.europa.eu/trade/

WITS: http://wits.worldbank.org/wits/

CEPII: http://www.cepii.fr/CEPII/en/bdd_modele/bdd.asp

UNCTAD: http://unctad.org/en/Pages/Statistics.aspx

GTAP: https://www.gtap.agecon.purdue.edu/

Feeenstra: http://cid.econ.ucdavis.edu/data.html

Literature and Resources II

Page 7


p. 4: „International economics is what international economists do,…, you will only know about intern-ational economics, once you have studied it your-self“.

„…I think that an important distinguishing cha-racteristic is the general equilibrium nature of this approach.“

This forces us to be precise and complete in our explanations.

Chapter 1: The World Economy – Some Stylized Facts

Page 8


Figure 1.1 Angus Maddison (1926 -2010)

* The portrait was painted by Carla Rodenburg in 2001. I am grateful to Angus Maddison for his permission to use this painting. Angus Maddison

Page 9


The economic size (power?) of a nation is best measured in terms of the total value of goods and services produced in a certain time period.

Other measures of size such as land area and population are weakly correlated with economic size – look at Russia, China, India, Brazil on the one hand, and on the European Countries on the other hand.

Chap. 1.2 and 1.3:

Page 10


1. Accurate data from the statistical offices in national currency (Maddison in our case).

2. Decide to look at GNP or GDP GDP + net receipts of factor income = GNP

GDP…market value of goods and services produced by labor and property located in a country.

GNP… market value of goods and services produced by labor and property of the nationals of a country.

3. Use the same currency ($): current US $ or PPP.

A size comparison across open countries needs three steps:

Page 11


The dotted line is a 45º line, the axes use a logarithmic scale, and the circles are proportional to the size of GDP .

GDP and GNI, 2008 (billion current $)

10

100

1,000

10,000

100,000

10 100 1,000 10,000 100,000

Gross Domestic Product, GDP

Gro

ss N

atio

nal I

ncom

e, G

NI

USA

China

Germany

Japan

Fig 1.2: GDP and GNP, 2008 ($ billion)

Page 12


Comparing income in current $ tends to overestimatethe differences between high and low income countries

(i) Tradable goods are subject to international competition so that the prices of such tradable goods tend to be equal when measured in the same currency.

(ii) Within a country producers of tradable and non-tradable goods compete for same resources (labor) so that the wage rate in each country reflects labor productivity.

(iii) Across countries differences in productivity in the non-tradable sectors tend to be smaller than in the tradable sectors.

In current $, the value of output tends to be under-estimated in low-income countries.

Purchasing Power Parity (PPP)

Page 13


Example: based on the current exchange rateCost of hair cut in the US: 10$Cost of hair cut in Tansania: 1$

So the same service is priced differently: the value of production in US is overestimated by a factor 10!

United Nation income comparison project (ICP) collects price data on goods and services in all countries of the world and calculates PPP comparing prices in local currencies.

P$=PTZS E$/TZS => implied PPP:

1

10

TZS

USTZS/E P

P E

Purchasing Power Parity (PPP)-continued

Page 14


Figure 1.3: Gross domestic product, 2008; top 15, ranked according to PPP

Page 15


Trade flows can readily compared using exchange rates.

We distinguish merchandise trade and trade in commercial services.

Stylized facts 2008 (see http://www.fiw.ac.at/ for more recent evidence):

China has been the largest merchandize trade exporter, followed by Germany and US.

US share in world exports is just 8.5%.

Many countries have a larger share in world exports than in world production (country size matters!).

1.5 International Trade

Page 16


The difference between exports and imports (trade balance) is more pronounced than the difference between GDP and GNP, but relative to the size of imports and exports the difference is small.

In 2008 China had the largest trade surplus in goods and services (349 bn $) followed by Germany (228 bn $).

US has the largest trade deficit (696 bn $).

In relative terms Brunei is the largest net exporter and Ethiopia the largest net-importer.

Trade openness is defined as the ratio of exports +imports to production. For Singapore this ratio is more than 234%.

Exports Relative to Imports

Page 17


The dotted line is a 45º line, the axes use a logarithmic scale, and the circles are proportional to the size of exports.

Exports and imports of goods and services, 2008 ($ bn)

1

10

100

1,000

10,000

1 10 100 1,000 10,000

export value

impo

rt v

alue

USA

GermanyChina

Russia

Saudi Arabia

Ethiopia

Brunei

Figure 1.4: Exports and imports of goods and services, 2008 ($ billion)

Page 18


Relative exports of goods and services, 2008 (% of GDP)

88

90

91

92

97

110

131

179

212

234

0 50 100 150 200 250

Malta

Macao

United Arab Emirates

Belgium

Bahrain

Malaysia

Seychelles

Luxembourg

Hong Kong

Singapore

Figure 1.5: Relative exports of goods and services, 2008 (% of GDP)

Page 19


Taxes on international trade, 2008 (% of revenue)

25

26

27

32

32

35

35

44

52

57

0 10 20 30 40 50 60

Russian Federation

Niger

Bangladesh

St. Kitts and Nevis

Maldives

Madagascar

Cote d'Ivoire

Namibia

Bahamas, The

Lesotho

Figure 1.6: Taxes on international trade

Page 20


Globalization defined by Neary (2002): The increased interdependence of national economies; trend towards greater integration of goods, labor and capital markets.

Globalization and Income: Income statistics based on Maddison’s work (in 1990 international Dollars (corrected for PPP, ensure transitivity, base country invariance and additivity).

Logarithmic scale (level and growth).

Big increase in GDP per capita in 1820 (industrial revolution).

Two waves of globalization: second half of 19th century and after WW2.

New institutional setting after WW2: income per capita +3% p.a., world income +5% p.a., world trade flows +8% .p.a.

1.6 Globalization

Page 21


World GDP per capita (1990 international $), logarithmic scale

5,709

435444 667

1820100

1,000

10,000

0 500 1000 1500 2000

Figure 1.7: Development of world per capita income over the last 2000 years

Page 22


Figure 1.8: Two waves of globalization in trade

Merchandise exports, % of GDP in 1990 prices

4.6

17.2

2.5

10.1

0.2

13.4

0

5

10

15

1870 1900 1930 1960 1990

world USA Japan

Page 23


Globalization and capital:

Two similar waves of globalization in the capital markets. Sharp increase in capital mobility since the 1960thies.

Globalization and migration:

Two modern waves of migration:

1820-1913: 40 millions migrants mainly form Europe to US, Canada, South America and Australia, young and mainly low skilled workers.

After WW2 (not yet ended): Since the 1990thies the source countries are now mainly Asian and Eastern European countries.

Many countries have quotas to restrict inward migration.

Labor markets are less globally integrated than goods and capital markets.

1.6 Globalization (continued)

Page 24


0.6

0.4

0.2

01860 1880 1900 19601920 1940 1980 2000

Foreign capital stocks; assets / world GDP0.6

0.4

0.2

01860 1880 1900 19601920 1940 1980 2000

Foreign capital stocks; assets / world GDP

Figure 1.9: Foreign capital stocks, assets / world GDP

Page 25


Relative annual immigration flows, 1870-1998 (per 1000)

-2

0

2

4

6

1870-1913 1914-1949 1950-1973 1974-1998

Western Europe Western Offshoots

Figure 1.10: Relative migration flows, Western Europe and Western Offshoots

Page 26


1.7: Some Stylized Facts for Austria

Page 27



Page 28


Austria‘s most important trading partners (exports in 2009)


Page 29



Austria‘s FDI Position

Page 30

Chapter 3Classical Trade: Technology

International Economics Page 31


Overview Ricardian (classical) model

• Technology differences between countries are the driving force behind international trade flows

• Relative (or comparative) differences are crucial, not absolute differences

• Absolute differences are important for determining a country’s wage rates and welfare level

• The production possibility frontier summarizes the state of technology and the available factors of production in final goods space

• Trade flows increase welfare (technology gains from trade)


David Ricardo (1772-1823)

“When a country can either import a commodity or produce it at home, it compares the cost of producing at home with the cost of procuring from abroad; if the latter is less than the first, it imports.”


Assumptions of the Ricardian technology model

• Two countries (EU and Kenya)• Two final goods (Food and Chemicals)• One factor of production (Labour)• Constant returns to scale production functions• Perfect competition• Labour is mobile between sectors, but not between countries.• Costless trade in final goods (no impediments to trade)• Technology as reflected by labor productivity differs between

countries

• General (example)


Technology differences between countries

Production technology is summarized in a productivity table:

Labour units required to produce one unit of output

Food Chemicals

EU 2 8

Kenya 4 24

The EU technology is more productive for both goods

The EU has an absolute advantage in Food production: it requires less labour (2 units instead of 4)

The EU also has an absolute advantage in Chemicals production: it requires less labour (8 units instead of 24)


Comparative advantage: productivity method


Food Chemicals

EU 2 8

Kenya 4 24

• The EU is twice as productive in the Food sector (4/2 = 2)• The EU is three times as productive in the Chemicals sector (24/8 = 3), so

The EU has a comparative advantage in Chemicals, and

Kenya has a comparative advantage in Food


• An extra unit of Chemicals needs 8 units of labor in the EU• This labor could have made 8/2 = 4 units of Food; the opportunity cost of Chemicals production in the EU is 4 Food.• An extra unit of Chemicals in Kenya needs 24 labor• This labor could have made 24/4 = 6 units of Food; the opportunity cost of Chemicals production in Kenya is 6 Food

Comparative advantage: opportunity cost method


Food Chemicals

EU 2 8

Kenya 4 24

The EU has a comparative advantage in Chemicals, Kenya in Food


The ppf is a straight line in the Ricardian model


Food Chemicals

EU 2 8

Kenya 4 24

• Suppose the EU has 200 units of labour available and Kenya has 120 units available (remember: it is just an example)• If all workers in the EU produce only Food, the EU can make 200/2 = 100 Food (and 0 Chemicals)• If all workers in the EU produce only Chemicals, the EU can make 200/8 = 25 Chemicals (and 0 Food)• Similarly, if all workers in Kenya produce Food total output is 120/4 = 30 Food (and 0 Chemicals); if they all produce Chemicals total output is 120/24 = 5 Chemicals (and 0 Food)


Definition: all possible combinations of efficient production points of final goods, given the available factors of production and the state of technology;

Note that:•It is a technical specification: the ppf does not depend on the type of market competition•The ppf depends on the available factors of production: if, e.g., more labour becomes available more goods can be produced•The ppf depends on the state of technology: if new techniques become available, output increases with the same use of inputs

Production possibility frontier (ppf)


Food

Chemicals0

30

255

100

Kenya ppf

EU ppf

A

B

CE

D

Food

Chemicals0

30

255

100

Kenya ppf

EU ppf

A

B

CE

D

Page 40

Production possibility frontiers

The EU can produce

(0 Chemicals, 100 Food) or

(20 Chemicals, 0 Food), or

any combination in between

Kenya can produce

(0 Chemicals, 30 Food) or

(5 Chemicals, 0 Food), or

any combination in between

F

C

F

C

F

EU

aa

EUaa

aL

EU

EUFEUCEU

:costsy Opportunit

CF :PPF

FaCaL :constraint Resurce


Production in the EU; pC/pF = relative price of Chemicals

• Producer maximizing profits in

this setting is equivalent to

maximizing total revenue, given

the final goods price ratio pC/pF

Food

Chemicals

EU

• If pC/pF is low, this implies only

production of Food

PrEU slope = - pC /p

F







Food

Chemicals

EU

• If pC/pF is high, this implies

only production of Chemicals

PrEU







Food

Chemicals

EU

• If pC/pF is equal to the slope of

the ppf, production can be

anywhere along the ppf (to be

determined by other factors)

•Under Autarky it must hold that

pC/pF is equal to the slope of the

ppf.


Gains form Trade

Food

Chemicals0

30

255

100

Kenya ppf

EU ppf

A

B

F

Kenyabudgetline

6.25

120

G

EU budgetline

Food

Chemicals0

30

255

100

Kenya ppf

EU ppf

A

B

F

Kenyabudgetline

6.25

120

G

EU budgetline

Relative to autarky trade increases the rel. price of chemicals in the EU (exporter) and decrease it in Kenya (importer).

Consumption can be extended in both trading partners (gains form trade).


Value of consumption =Value of production, trade is balanced in each country.

Product prices are determined at the World market equating world demand =world supply.

Marginal rate of substitution of consumers = PC/PF.

Wages have to adjust according to productivity in each country .

Due to lower wages food producers of Kenya (holding the comparative advantage) are competitive on the world market.

Equilibirum

EUF

EUc

F

CK

EU

KF

K

EUc

EU

F

C

a

aPP

ww

aw

awPP

1

1


Some empirical evidence

Figure 3.5 Kenya–EU exports and productivity, various sectors

-50

0

50

100

0 50 100 150 200

Relative productivity ratio (Kenya/EU); %

Ken

ya e

xpor

t (%

) -

impo

rt (

%)

food

chemicalsmachinery


Some empirical evidence - continued

The Balassa index

j good incountry A of advantage ecomparativ Revealed 1BI

exportscountry reference in jindustry of Share

exportscountry A in jindustry of ShareBI

Aj

Aj

Exports of 28 manufacturing sectors for the member of OECD countries

Reference country is the group of all OECD countries

Observe high values for countries with a smaller industrial base such as Italy and Finland.

Observe the persistence of comparative advantages.



Figure 3.7 Highest Balassa index, selected countries



Figure 3.7 Highest Balassa index, selected countries

c Brazil

0

2

4

6

8

10

12

14

16

18

20

2001 2002 2003 2004 2005 2006 2007 2008

Oil seed, oleagic fruits, grain, seed, fruit, etc, nes

Sugars and sugar confectionery

d USA

0

1

2

3

4

5

2001 2002 2003 2004 2005 2006 2007 2008

Works of art, collectors pieces and antiques

Aircraft, spacecraft, and parts thereof


Concluding remarks, Ricardian (classical) model

• Technological differences between countries are the classical driving force for international trade flows.

• Only comparative costs, not absolute costs, are important for determining the direction of trade flows.

• Absolute costs are important for determining a country’s welfare level.

• Allowing for more countries and more goods is easy, allowing for more than one factor of production is not (see neoclassical model).


Production Structure

Chapter 4


Overview Production Structure

• The neoclassical model focuses on differences in relative factor endowments as a cause for international trade flows.

• The main contributors are Eli Heckscher, Bertil Ohlin, and Paul Samuelson: it is therefore referred to as the HOS model.

• This chapter reviews the production structure of the model.• Neoclassical production functions with two inputs and

constant returns to scale.• Optimizing economic agents, taking prices as given.• The impact of technology differences is analyzed in Chapter

3, we therefore assume identical technology from now on.


Paul Samuelson (1915–2009)

“Funeral by funeral, theory advances”

www.brainyquote.com


Assumptions of the neoclassical (HOS) model

• Two countries (Austria and Bolivia)• Two final goods (Food and Manufactures)• Two factors of production (Capital and Labour)• Constant returns to scale production functions• Perfect competition in all markets• Capital and Labor is mobile between sectors, but not between

countries• Costless trade in final goods (no impediments to trade)• Identical production technology in the two countries• No factor-intensity reversal• Identical homothetic tastes in the two countries• Countries differ in their (relative) factor endowments

• General (example)


Main results of the neoclassical (HOS) model

The HOS model derives 4 main propositions in Chapters 5-7:• Factor Price Equalization: Trade in goods (which equalizes

final goods prices) leads to the equalization of factor prices.• Stolper-Samuelson theorem: An increase in the price of a

final good increases the (real) reward to the factor used intensively in the production of that good and reduces the (real) reward to the other factor of production.

• Rybczynski theorem: An increase in the quantity of a factor of production, at constant final goods prices, leads to an increase in the production of the good using that factor intensively and a decreased production of the other good.

• Heckscher-Ohlin theorem: A country will export the final good which makes relatively intensive use of the relatively abundant factor of production.


Neoclassical production functions

Characteristics of our neoclassical production functions• Two inputs: capital (K) and labour (L)• Substitutability: a given output level can be produced using

different combinations of inputs, i.e. the use of one input can be substituted for the use of another input

• Positive marginal product: if more capital or more labour is used output increases

• Diminishing marginal product: given the use of capital, an increase in the use of labour leads to ever smaller increases in output (similarly for capital)

• Constant returns to scale: an increase in the use of both inputs by z% also leads to an increase in output of z%


capital owners

labourers

consumers

production manufactures

production food

producers

capital services

(rental income)

labour services

(wage income)

delivery of food (spending (1-m) on food)

delivery of manufactures (spending m on manufactures)

direction of goods and services flows(direction of money flows)

Structure of the equilibrium


Production functions: substitutability and isoquant

• Let M be the output of

Manufactures, Km the input of

capital, Lm the input of labour

and m a capital intensity

parameter (0 < m < 1); this is a

possible production function:

Capital

Labour

• The figure on the left depicts

an isoquant for this function;

note the substitutability

between capital and labour

mmmm LKM 1

isoquant


M=0.7

Production is constant returns to scale (CRS)

• At point A1 production M = 1Capital

Labour

M=1

A1

A2

B2

B1

• Reducing inputs by 30%

leads to point A2

• CRS implies at point A2

production M = 0.7

• Similarly for points B1 and B2

• Conclusion:

isoquant M = 0.7 is a radial

blow-up of isoquant M = 10.7 D

0.3 D

D


Profit maximization: two-step procedure

Producer profits = revenue – production costs

Maximizing profits is a two-step procedure• First, given how much you want to produce: minimize

production costs• Second: determine the optimal output level


Cost minimization

• Suppose you want to

produce M=1 at minimum cost

taking wage rate w and rental

rate r as given

• Total cost = wLm + rKm , a

straight line in (labour, capital)

space with slope = - w/r

Capital

Labour

• Minimum costs are achieved

at a point of tangency

between the isocost line and

the isoquant; point A, using K

capital and L labour

M=1

slope = -w/rL

KA


Constant returns to scale and production costs

Under constant returns to scale (CRS) the isoquants are radial blow-ups of one another

Minimizing production costs is now simple:•First, we determine the cost-minimizing input combination for producing one unit of output, say K and L•Second, determine the output level, say z units. Proportionally adjust the unit inputs to produce z output, so using: zK and zL•Under CRS: total cost = (per unit cost) output


Profit maximization, CRS, and perfect competition

Profits = [price – (per unit cost)] output

There are three possibilities• price < unit cost: optimal output level = 0, no profit• price = unit cost: optimal output level undetermined (can be

determined by other factors); profit level = 0• price > unit cost: optimal output level = infinite, profit level

is infinite not possible in economic equilibrium

Conclusion: CRS + perfect competition implies:• price unit cost• output > 0 price = unit costs


Impact of a fall in the wage rate

The figure shows the cost-

minimizing input combination

at point A for the ratio w0/r

Suppose the wage rate falls to

w1; rotates the isocost line

Capital

Labour

Minimum costs are now

achieved at point B with a

lower capital/labor ratio

M=1

slope = -w0 /r

Aslope = -w

1 /r

B

K/L

0

K/L 1


Food production with lower capital intensity

• The figure shows the cost-

minimizing input combination

at point A for M=1 and w/r

• Suppose Food production

has a lower capital-intensity

parameter: F < M

Capital

Labour

• For the same w/r minimum

costs for Food production are

at point B with a lower

capital/labour ratio

M=1

A

K/L

M

slope = -w/rK/LF

F=1

B


Empirical Evidence

0

10

20

30

40

50

60

70

80

Switzerland

W. Germany

USAJapan

India

UK

Figure 4.4 Capital stock per worker×1000 $; 1990 in 1985 $


Empirical Evidence – continued

Primary products exports (% of country's manufacturing exports), 2008

0 10 20 30 40 50 60 70 80 90

EthiopiaBrazil

AustraliaIndonesia

VietnamPakistan

NetherlandsSpainIndia

ThailandFrance

CanadaMalaysia

PolandUSA

BelgiumPhilippines

WorldItaly

SwedenAustria

Un KingdomMexico

GermanyNorway

BangladeshSwitzerland

ChinaRussia

Un Arab EmSingapore

Hong KongNigeriaTaipei

Korea SouthJapan

Saudi Arabia


Concluding remarks Production Structure

• The neoclassical (HOS) model explains trade flows based on differences in relative factor abundance

• The HOS model derives 4 main propositions• Production uses 2 inputs (substitution between inputs) under

constant returns to scale (CRS)• The cost-minimizing input combination depends on:

– The capital-intensity parameter ()– The wage-rental ratio (w/r)

• With CRS and perfect competition: – if a good is produced price = unit production costs

Documents

International Economics: Trade Theory and Policy WS 2013/14 Christen/Leiter/Pfaffermayr Lecture: