Economic Growth And International Trade

ANHUI UNIVERSITY OF FINANCE & ECONOMICS 1/31

Economic Growth and International Trade

Chapter 7


1 Introduction 1 Introduction We will We will Extend our trade model to include such changes as Extend our trade model to include such changes as factor endowments, technology and tastes, and their factor endowments, technology and tastes, and their effects on the nation's offer curve, the volume and effects on the nation's offer curve, the volume and terms of trade, and the gains from trade.terms of trade, and the gains from trade. Discuss Rybczynski theorem. Discuss Rybczynski theorem. Define different types of technical progress and Define different types of technical progress and their effects on the nation's production frontier.their effects on the nation's production frontier. Examine the effect of growth and change in tastes Examine the effect of growth and change in tastes in both nations on the trade volume and terms of in both nations on the trade volume and terms of trade.trade.


Key Terms• Comparative staticComparative static• Dynamic analysisDynamic analysis• Balanced growthBalanced growth• Immiserizing growth Immiserizing growth • Labor/capital saving technical progressLabor/capital saving technical progress• Protrade production and consumptionProtrade production and consumption• Neutral technical progress Neutral technical progress • Normal goodsNormal goods• Rybczynski theorem Rybczynski theorem • Wealth effectWealth effect


2 Static, Comparative Static 2 Static, Comparative Static and Dynamic Analysisand Dynamic Analysis

Static Analysis Up to the present, we only have static analysis except the analysis of product cycle and technological gap models.Comparative Static Analysis It analyzes the effect on the equilibrium position resulting from a change in underlying economic conditions and without regard to the transitional period and process of adjustment.Dynamic Analysis It deals with the time path and the process of adjustment itself.


3 Growth of Factors 3 Growth of Factors Capital: Capital: It refers to all man-made means of production, It refers to all man-made means of production, such as machinery, factories, office buildings, such as machinery, factories, office buildings, transportation and communications and also the transportation and communications and also the education and training of the labour force, all of education and training of the labour force, all of which greatly enhance the nation's ability to which greatly enhance the nation's ability to produce goods and services.produce goods and services.Assumptions:Assumptions: All labor and capital are homogeneous.All labor and capital are homogeneous. X is L-intensive and Y is K-intensive.X is L-intensive and Y is K-intensive. Nations experience growth in the production Nations experience growth in the production of X and Y under constant returns to scale.of X and Y under constant returns to scale.


3.1 Balance Growth3.1 Balance Growth


3.2 Unbalance Growth


3.3 K and L Growth Over Time3.3 K and L Growth Over Time When both L and K grow at the same rate and we have constant returns to scale in the production of both commodities, the productivity and the returns of L and K remain the same after growth as they were before growth took place. If the dependency rate, the ratio of dependents to the total population, also remains unchanged, real per capita income and the welfare of the nation tend to remain unchanged.

If only L grows or L grows proportionately more than K, K/L will fall, the productivity of L and the returns to L and real per capita income will also fall. If on the other hand, only K grows or K grows proportionately more than L, K/L will rise, the productivity of, the returns to L and real per capita income will also rise.


3.4 The Rybczynski Theorem


3.5 Technical Progress & PPF All types of technical progress cause the PPF to shift All types of technical progress cause the PPF to shift outwards. outwards. The type and degree of the shift depend on the type The type and degree of the shift depend on the type and rate of technical progress in either or both commodities. and rate of technical progress in either or both commodities.

With the same rate of With the same rate of neutral technical progress in neutral technical progress in the production of both the production of both commodities, the PPF will shift commodities, the PPF will shift out evenly in all directions at out evenly in all directions at the same rate at which the same rate at which technical progress takes place. technical progress takes place. The slope of the nation's old The slope of the nation's old and new PPF will be the same and new PPF will be the same at any point where they are cut at any point where they are cut by a ray from the origin.by a ray from the origin.


If the technical progress only takes place in the L and If the technical progress only takes place in the L and K K in the production of X or Y,in the production of X or Y, the production frontier will the production frontier will extend along the axis which shows the quantity of X or Y. extend along the axis which shows the quantity of X or Y.

X doubles for each level of Y.X doubles for each level of Y.

3.6 Neutral Technical Progress3.6 Neutral Technical Progress


3.7 Summary of Technical Progress

In the absence of trade, all types of technical progress tend to increase the nation’s welfare. The reason is that with higher production frontier and the same L and population, each citizen could be better off after growth than before by an appropriate redistribution policy.


4 Pro-and Anti-trade ProductionIf the output of the nation’s If the output of the nation’s exportable commodity grows exportable commodity grows proportionately more than the proportionately more than the output of its importable output of its importable commodity at constant relative commodity at constant relative commodity prices, then growth commodity prices, then growth leads to a greater than leads to a greater than proportionate expansion of proportionate expansion of trade. It is called protrade trade. It is called protrade production. Otherwise it is production. Otherwise it is antitrade production. antitrade production. Neutral trade production:Neutral trade production:The expansion of output leads The expansion of output leads to the same rate of expansion of to the same rate of expansion of trade.trade.


4.1 Pro-and Anti-trade 4.1 Pro-and Anti-trade ConsumptionConsumption

The nation’s consumption of its importable commodity increases proportionately more than the nation’s consumption of its exportable commodity at constant prices, the consumption leads to a greater than proportionate expansion of trade and it is called protrade consumption. Otherwise it is antitrade or neutral consumption.


4.2 Effects of Growth on Trade What happens to the volume of trade in the process of What happens to the volume of trade in the process of growth depends on the net result of these production and growth depends on the net result of these production and consumption effects.consumption effects. If production and consumption are both protrade, the If production and consumption are both protrade, the volume of trade expands proportionately faster than volume of trade expands proportionately faster than output.output. If production and consumption are both antitrade, the If production and consumption are both antitrade, the volume of trade expands proportionately less than volume of trade expands proportionately less than output and may even decline absolutely.output and may even decline absolutely. If production is protrade and consumption is antitrade, If production is protrade and consumption is antitrade, or vice versa, the volume of trade can not be decided. It or vice versa, the volume of trade can not be decided. It depends on the net effect of the two opposing forces.depends on the net effect of the two opposing forces. If production and consumption are both neutral, the If production and consumption are both neutral, the volume of trade expands at the same rate as output.volume of trade expands at the same rate as output.


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4.3 I l lustration of Factor Growth 4.3 I l lustration of Factor Growth and Trade: The Small Country and Trade: The Small Country

CaseCase


4.3 I l lustration of Factor Growth 4.3 I l lustration of Factor Growth and Trade: The Small Country and Trade: The Small Country

CaseCase


4.4 Technical Progress, Trade & 4.4 Technical Progress, Trade & WelfareWelfare

Neutral expansion of production and Neutral expansion of production and consumption leads to the same rate of expansion of consumption leads to the same rate of expansion of trade. With neutral production and protrade trade. With neutral production and protrade consumption, the volume of trade would expand consumption, the volume of trade would expand proportionately more than production. With neutral proportionately more than production. With neutral production and antitrade consumption, the volume production and antitrade consumption, the volume of trade would expand proportionately less than of trade would expand proportionately less than production. production. However, regardless of what happens to the However, regardless of what happens to the volume of trade, the welfare of the representative volume of trade, the welfare of the representative citizens will increase with constant L and population citizens will increase with constant L and population and constant terms of trade.and constant terms of trade.


5 Growth and Trade: The Large 5 Growth and Trade: The Large Country CaseCountry Case

Terms-of-trade effect of growth:Terms-of-trade effect of growth: If growth expands the volume of trade at constant If growth expands the volume of trade at constant prices (constant exchange rate), then the terms of trade prices (constant exchange rate), then the terms of trade tend to deteriorate.(Why?) On the other hand, if growth tend to deteriorate.(Why?) On the other hand, if growth reduces the volume of trade at constant price (constant reduces the volume of trade at constant price (constant exchange rate), the nation's terms of trade tend to exchange rate), the nation's terms of trade tend to improve. This is referred to as the terms-of-trade effect improve. This is referred to as the terms-of-trade effect of growth.of growth.Wealth effect of growth:Wealth effect of growth: The wealth effect is the change in the output per The wealth effect is the change in the output per worker or per person as a result of growth. A positive worker or per person as a result of growth. A positive wealth effect (higher productivity of labor) tends to wealth effect (higher productivity of labor) tends to increase the nation's welfare. Otherwise, the nation's increase the nation's welfare. Otherwise, the nation's welfare tends to decline or remain unchanged. welfare tends to decline or remain unchanged.


The effect of growth on the nation's welfare depends The effect of growth on the nation's welfare depends on the net result of the terms of trade effect and a wealth on the net result of the terms of trade effect and a wealth effect. If both are positive, the nation's welfare will effect. If both are positive, the nation's welfare will definitely increase. definitely increase. If both are unfavorable, the welfare will definitely If both are unfavorable, the welfare will definitely decline. If the wealth effect and the terms of trade effect decline. If the wealth effect and the terms of trade effect move in opposite directions, the nation's welfare may move in opposite directions, the nation's welfare may deteriorate, improve or remain unchanged, depending deteriorate, improve or remain unchanged, depending on the relative strength of these two opposing forces.on the relative strength of these two opposing forces.

If wealth effect(positive) is greater than the terms of If wealth effect(positive) is greater than the terms of trade effect(negative), the welfare increases. If wealth trade effect(negative), the welfare increases. If wealth effect(positive) is smaller than the terms of trade effect effect(positive) is smaller than the terms of trade effect (negative), the welfare decreases.(negative), the welfare decreases.

5 Growth and Trade: The Large 5 Growth and Trade: The Large Country CaseCountry Case


5.1 I l lustration of Growth and 5.1 I l lustration of Growth and Trade in a Large NationTrade in a Large Nation


5.2 Growth and Trade: The Large Country Case

Large Country Case Small Country CaseLarge Country Case Small Country Case


5.3 Immiserizing Growth5.3 Immiserizing Growth


5.4 Conditions for Immiserizing 5.4 Conditions for Immiserizing GrowthGrowth

When growth tends to increase nation 1’s exports substantially at constant terms of trade. Nation 1 is large so that the attempt to expand its exports substantially will cause a deterioration in its terms of trade. The income elasticity of nation 2’s demand for nation 1’s export is very low, so that nation 1’s terms of trade will deteriorate substantially. Nation 1 is so heavily dependent on trade that a substantial declining in its terms of trade will lead to a reduction in national welfare.


5.5 I l lustration of Beneficial 5.5 I l lustration of Beneficial Growth and TradeGrowth and Trade


5.6 Growth Increasing Terms of 5.6 Growth Increasing Terms of Trade and WelfareTrade and Welfare


6 Growth & Trade in Both Nations6 Growth & Trade in Both Nations


Through time not only do economies grow, but national tastes also change.

Growth affects a nation’s offer curve through the effect that growth has on the nation’s production frontier. Similarly, a change in tastes affects a nation’s offer curve through the effect that the change in tastes has on the nation’s indifference map.

With growth or change in tastes in both nations, both nations’ offer curves will shift, changing the volume or the terms of trade.



Regardless of its source, a shift in a nation’s offer curve toward the axis measuring its exportable commodities tends to expand trade at constant exchange rates and reduce the nation’s terms of trade. Opposite shifts in the nation’s offer curve tend to reduce the volume of trade at constant exchange rates and improve the nation’s terms of trade. For a given shift in its offer curve, the nation’s terms of trade will change more, the greater the curvature is of its trade partner’s offer curve.



7 Questions for Discussion7 Questions for Discussion• What effect do the various types of factor

growth have on the growing nation’s production frontier?

• Explain neutral, labour saving and capital saving technical progress?

• What are protrade or antitrade production and consumption?

• What are the effects of different technical progress in the large and small nation?


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Economic Growth And International Trade