Lecture 7: Globalization & international trade
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By now, hopefully familiar with the trend in
international trade over the past 200 years.
That is, trade went up and by a lot with increases
along two margins, the extensive and intensive.
What is striking in the aggregate, though, is the
apparent regularity of this growth.
What forces govern this pattern?
Introduction
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Introduction
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Remaining question for this week:
What are the long-run determinants of trade?
1.) Particularly, what determines its composition?
Or who trades what with whom?
2.) And what determines its dimensions?
Or who trades how much with whom?
Introduction
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We have already considered one approach to
explaining the composition of trade.
The Heckscher-Ohlin (HO) model was used by
O’Rourke and Williamson to explain the Great
Specialization.
Their evidence seemed to indicate that
commodity price convergence
Revisiting HO
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A recap on HO: it critical assumptions
1.) Endowments of factors of production
assumed to be different across countries.
2.) Factor intensities across industries assumed to
be different.
---------------------------------------------------------------------------------------------------------
3.)
4.)
Revisiting HO
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A recap on HO: it critical implications
1.) Stolper-Samuelson Theorem: an increase in
the relative price of a good will increase the
real return to the factor used intensively in
the production of that good.
2.) Factor price equalization: free trade will tend
Revisiting HO
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A recap on HO: it historical application
The 1800s saw trade costs fall and trade boom,
inducing commodity price convergence.
HO predicts that the UK will have exported
manufacturers and NA will have exported
agricultural goods and other commodities.
Revisiting HO
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And what about relative factor returns?
In the UK, the formerly scarce factor (land)
suffers while the formerly abundant factor
(labor) benefits…w/r should increase.
In NA, the formerly scarce factor (labor) suffers
while the formerly abundant factor (land)
benefits…w/r should decrease.
Revisiting HO
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But the success of HO in explaining trade
patterns during the Great Specialization probably
not all that surprising.
Written at the time (indeed, a little after the fact);
also, based on close empirical observation of
trade patterns.
Revisiting HO
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By far, extending and testing the HO model was
the predominant activity in international trade
literature from 1950s into 1980s (and beyond).
It all started with Leontief (1953)—the first
attempt to confront the model with data.
Building on work on constructing input-output
Leontief’s paradox
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Input-output coefficients combined with trade
data to compute amounts of L and K used in the
production of US exports and imports.
Last element calculated by applying the same US
input-output matrix for all of its trading partners.
Assuming same matrix implies same technology
(that is, same efficiency in transforming input
into output).
Leontief’s paradox
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Exports
Imports
Capital Requirement
(millions of USD)
A(Kx) = 2.55
A(Km) = 3.09
Labor Requirement
(person-years)
A(Lx) = 182.31
A(Lm) = 170.11
By taking the ratio of the K and L requirements,
we can find the amount of capital used by each
worker in the production of X and M.
K/Lx = kx = $2.55 million / 182.31 = $13,987
Leontief’s paradox
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This implies that km = 1.30 kx.
This gave rise to Leontief’s paradox: US imports
were 30% more K-intensive than US exports.
But how could this possibly be?
In 1947, the US held approximately 60% of the
world’s capital stock
Leontief’s paradox
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Proposed solutions for the paradox:
1.) disaggregated factors of production; Leontief
only used K and L, but there are more.
2.) 1947 was unrepresentative; WWII just ended
and global economy not back on its feet.
3.) US was not engaged in free trade
Leontief’s paradox
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Big assumption of common worldwide
technology embedded in input-output matrix:
a bad precedent which Leontief fought.
Lead to many negative results, but little
information on sources of HO’s failure:
1.)
2.)
3.)
Leontief’s paradox
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One of the chief criticisms of Leontief’s study
was the crude classification of K and L.
This, of course, followed the classic HO model
of a 2x2x2 world that we have seen before.
But this was obviously unrealistic, even in the
world of 1947.
Revising HO
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Even with just three factors and two countries, it
can become messy: K/L>K*/L* and R*/L*>R/L
does not imply anything about K/R or K*/R*.
Normalization matters; most convenient way of
comparing across countries and factors is to
normalize by GDP shares.
Revising HO
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At the same time, want to allow for corrections
in the raw data used to compare endowments.
For example, labor endowments could be
measured by population, but what if
demographics were different across countries.
Likewise, land endowments could be measured
by land mass, but what if soil quality differs.
Revising HO
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Revising HO
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Allowing for more factors and differences in
factors, researchers have been able to retest HO
theory by using ―the sign test‖:
Sign of (country’s share of effective factor
minus
country’s share of world GDP)
Revising HO
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Leading us to the question: what is the factor
content of net exports exactly?
Most directly, the factor content of exports minus
the factor content of imports; anything more?
Most importantly, it measures the amounts of
each factor used to produce exports and imports.
Revising HO
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The example from before: the US in 1947
Exports
Imports
Capital Requirement
(millions of USD)
A(Kx) = 2.55
A(Km) = 3.09
Labor Requirement
(person-years)
A(Lx) = 182.31
A(Lm) = 170.11
Gross exports of 16,700 million USD and
gross imports of 6,200 million USD.
Revising HO
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K content of gross exports =
16,700 * 2.55 m USD = 42,585 m USD
L content of gross exports =
16,700 * 182.31 = 3,044,577 p-years
K content of gross imports =
6,200 * 3.09 m USD = 19,158 m USD
Revising HO
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K content of net exports =
42,585 – 19,158 = 23,427 m USD
L content of net exports =
3,044,577 – 1,054,682 = 1,989,895 p-years
Because both positive, sign test would predict
that US’s share of world K and L (60% and 8%)
Revising HO
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Moving towards the more recent past, Trefler is
the definitive work on completely testing HO
(data on endowments, trade, and technology).
His data: f = 9 factors (K, 6 labor, 2 land) for
c = 33 countries (high, middle, & low income).
33 countries x 9 factors = 297 sign tests versus
Leontief’s 2; implies a lot more power.
The missing trade puzzle
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Looking at the sign test over all of these
possible combinations, Trefler finds that the
success rate is again 50/50.
The underlying equation for his sign test is:
Ffc= Vfc − scVfw
Ffc= c’s factor content of net exports for factor f
Vfc= c’s endowment of f
The missing trade puzzle
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Thus, if c effectively exports f (on net), then
Ffc>0 → Vfc−scVfw>0 → Vfc>scVfw → Vfc/Vfw>sc
But let’s also think about the errors generated by
the predictions of HO and define the following:
Errorfc =
In the strict HO world, Efc should equal zero.
For the weaker sign test, we would expect there
to be at least a positive correlation between
The missing trade puzzle
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If Ffc = 0, then Efc = −(Vfc − scVfw)…45º line
The missing trade puzzle
The missing trade puzzle
Suggests there is much more going on…
obvious candidate is technological differences.
All countries & the sign test: 50%
High GDP countries: 59%
Middle GDP countries: 48%
Low GDP countries: 38%
Once Trefler corrects for these, accuracy of sign
test ranges from 59 to 66%
The missing trade puzzle
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A few other issues emerge in considering relative
factor endowments as the only determinant of the
composition of international trade.
It is silent about role of monopolistic competition
& rise of intra-industry trade from 1950s.
It is silent about role of firms (especially MNCs)
& rise of vertical specialization from 1970s.
Moving beyond HO
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As it turns out, many of these perspectives can
be integrated by considering trade costs.
Trade costs:
Could potentially include:
1.) freight & time costs
2.) tariffs & non-tariff barriers
3.) costs from the use of different currencies
4.) …
Moving beyond HO
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A large literature accounting for trade costs and
how they explain the volume of bilateral trade.
The workhorse of empirical international trade:
the gravity model.
Relates bilateral volumes of trade to GDP and
measures of trade costs.
Moving beyond HO
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But why ―gravity‖?
M1  M 2
Fg  G
2
d
GDP1  GDP2
Trade12  B
dn
Here, B is a term which will include many trade
cost elements (not related to distance).
Moving beyond HO
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Beyond agreement with common sense, gravity
model is also attractive in that:
1.) it is consistent with competing models of
trade; tells us how consumers allocate spending,
given patterns of specialization and trade costs.
2.) it allows us to estimate trade costs over time.
Moving beyond HO
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Moving beyond HO
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Moving beyond HO
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Moving beyond HO
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In trying to chart the composition and
dimensions of trade, we began with HO.
Its broad relevance for the 19th century and early
20th century explains its continued use.
But while endowments still matter, we also need
to think about other issues now related to
patterns on production and specialization.
Conclusion
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