I. International Trade and
development
Raul Caruso
Università Cattolica del Sacro Cuore
di Milano
raul.caruso@unicatt.it
1
Let’s Start
2
The main question of this course is:
Does trade help economic development?
How?
3
World Trade and World Income
4
World Trade and World Income
5
World Trade and World Income
6
World Trade and Income
7
Trade and World Income
8
The question is still:
Does Trade cause GDP growth?
The answer seems to be YES
9
Trade and Income
(Frankel and Romer 1999)
10
Frankel and Romer 1999
Frankel and Romer (1999) find that:
(1) There is a positive effect of trade on income(economic factors). The levl of income is
increasing in trade share
(2) Increased size of the countries raises income.
(geography matters)
11
Trade Share or Trade Openess Ratio
Trade Openess Ratio
The trade-to-GDP-ratio is the sum of exports and imports divided
by GDP. This indicator measures a country's "openness" or
"integration" in the world economy. It represents the combined
weight of total trade in its economy, a measure of the degree of
dependence of domestic producers on foreign markets and
their trade orientation (for exports) and the degree of reliance
of domestic demand on foreign supply of goods and services
(for imports).
Trade Openess Ratio
X M

GDP
12
For example consider these countries
Trade/GDP 2004
Constant prices
Australia
Austria
France
Germany
Italy
Japan
Poland
UK
USA
Belgium
48,6
102,4
57,8
76,42
51,37
23,62
69,75
60,2
26,5
173,7
Source: OECD
13
Trade and Income, One more time…
Harrison (2006)
14
However,….
Even if cross-country studies point to a positive
relationship between globalization and overall
growth, such growth may lead to unequal gains
across different levels of income. If the growth
effects on average are small trade-induced
growth could be accompanied by a decline in
incomes of the poor.
15
Trade and Poverty
Harrison (2006)
16
Finally
Therefore it seems that:
There is an association between poverty
reduction and trade.
But aggregate studies sometimes are
misleading
17
Main points or main questions?
According to Harrison (2006) the evidence suggests that the
poor are more likely to share in the gains from
globalization when there are complementary policies in
place:
(1)investments in human capital and infrastructure;
(2)policies to promote credit and technical assistance to
farmers
(3)policies to promote macroeconomic stability.
(4)trade and foreign investment reforms have produced
benefits for the poor in exporting sectors and sectors that
receive foreign investment.
(5)Financial crises are very costly to the poor.
Finally, evidence suggests that globalization produces both
18
winners and losers among the poor.
To continue….
Therefore,
(1) Trade and development exhibit a
complex association
(2) Nowadays in 2010 in the aftermath of
the global crises the picture could be
completely different
(3) We have first to go back to the basic
economic theories of trade
19
Consider that USA
is the largest country in the world
with over the 21% of world income
17% of world imports and
10% of world exports
20
Basic Economics of Trade
The Ricardian Model
21
Comparative Advantage
Ricardo (1817)
(1)A country(region) has a comparative
advantage in producing a good (say
clothing) if the opportunity cost of
producing that good in terms of other
goods is lower in that country than it is in
other countries.
(2)Eventually this country specializes in the
production of clothing.
(3)It will export clothing.
22
Assumptions of Ricardian World
(1) There are 2 countries: Home and
Foreign
(2) Consider only two goods: cheese and
wine
(3) There is only one factor of production:
Labor
(4) Labor Productivity are constant
23
Some notations
• The Home economy can be described by the following
relation (see Krugman):
• Where
aLC Qc  aLW QW  L
aLi , i  c, w
denote Unit Labour Requirements. In other words, they
are coefficients capturing costs and technology of
production. In this simplest case they denote how many
hours are needed to produce a unit of a good.
24
More….
• Note also that the ratio:
aLC
aLW
Can be defined as the opportunity cost of cheese in
terms of wine. That is how many units of wine I
have to give up in order to have 1 unit of cheese
25
For example…..
• If
aLC 1

aLW 2
This means that in order to have 1 extra unit of cheese
I have to give up 1/2 units of wine.
In one hour of work a person is supposed to produce 1
unit of cheese or ½ unit of wine.
26
Identifying Comparative Advantage
• To have CA we must have:
*
LC
*
LW
aLC a

aLW a
(1)
That is, Home country has a comparative
advantage in Cheese.
27
What about Prices?
• Assume prices depending upon (1) cost ;
(2) demand and supply.
• In autarky the relative prices of goods
equal their relative unit labour
requirements:
pc
aLC

pw
aLW
28
What about Prices?
• Note that if:
pc aLC

pw aLW
The Economy will specialize in the production of
cheese if the relative price of cheese exceeds its
opportunity cost
29
Prices and CA
• In the presence of CA we have:
a*LC
aLC
pc

 *
aLW pw a LW
In the presence of trade the relative price of
cheese must lie between the opportunity cost
of cheese in terms of wine in Home and the
opportunity cost of cheese in terms of wine in
Foreign
30
Prices and CA
• Consider the case:
*
aLC a LC
pc
 * 
aLW a LW
pw
Both Home and Foreign will produce cheese. There
will be no wine. The supply of cheese goes to
infinity.
31
A numerical example of CA
Unit Labor Requirements
Home
Foreign
Cheese
1
6
Wine
2
3
See Krugman-Obstfeld, chap. 2
Note: Home has higher labor productivity in both industries
In H the opportunity cost of producing cheese in terms of wine = ½
In F the opportunity cost of producing cheese in terms of wine =2
32
Production and Consumption in
Autarky
Units produced in Autarky
Labor Supply=100,
Cheese
Wine
Home
70
Foreign
11
World
81
15
10
25
33
A numerical example of CA
Unit Labor Requirements
Home
Foreign
Cheese
1
6
Wine
2
3
See Krugman-Obstfeld, chap. 2
Assume that in world equilibrium the relative price is
Pc/Pw=1
Home will specialize in cheese production.
Home workers can earn more by producing cheese
34
Production and Consumption with
Trade
Units produced in tre presence of Trade
Labor Supply=100
Cheese
Wine
Home
100
Foreign
0
World
100
0
33
33
*
L
L
YC 
; YW*  *
aLC
aLW
35
Production and Consumption with
Trade
• Consumption and Production Possibilities are
higher in the presence of trade
• Supply of both goods is larger
36
A trick?
Note that in the example above we have:
aLW  a
*
LW
That is, Home is more productive also in the production of
wine, because it needs only two hours of work whilst Foreign
country needs three (see the table). This is a case of Absolute
Advantage
Is it a Trick? NO. The CA theory suggests that each country
specializes in the production of good in which it has the
RELATIVELY lower unit labor requirements
37
Another Example
Ham
200
100
Home
Foreign
aham
200

 25
a peppers
8
a peppers
aham
8

 0.04
200
*
aham
100

4
*
a peppers 25
a*peppers
*
ham
a
25

 0.25
100
Peppers
8
25
*
aham
aham

*
a peppers a peppers
a peppers
aham

a*peppers
*
aham
38
Another example
(1) Foreign has CA in Ham
(2) Home has CA in Peppers
Foreign does specialise in Ham
Home does specialise in Peppers
39
CA Theory’s Legacy
• Productivity differences play a role in
international trade
• Comparative Advantage rather than Absolute
advantage matters
• Evidence confirms that countries tend to
export goods in which they have relatively
high productivity
40
Measuring Comparative Advantage
•
Belassa Index of Comparative Advantage
X ijt / X wjt X ijt / X wjt
bijt 

X it / X wt
ED
where – for every time period t considered – i denotes a specific country,
w indicates the world economy (i.e. the entire set of countries
considered in the analysis), and j is a specific sector. b is, therefore, a
sectoral relative export measure in terms of share of world exports.
Since the numerator ranges from 0 (the country is not exporting
products belonging to that particular sector) to 1 (the country is an
international monopolist in such category of products), and the
denominator which is the economic dimension of the country, in export
terms – also ranges from 0 to 1, then b ranges between 0 and ED.
41
Some Elaborations
Source: De Benedictis (2005)
42
A very simple model to explain
competitiveness
• Consider only one factor of production: Labor.
• This assumption holds in the short-run
• The Unit labour cost is the key factor
• The ULC can help us for a prediction of CA
• Prices depend upon ULC
43
Notations
Consider
Employement =N
Average Hours=AH
Production = Y
Labor Productivity= LP
Wage = W
Unit Labor Cost =ULC
Exchange Rate = E
44
A very simple model
You have N, Y, AH, W and E Then, The total
hours worked (TH) are simply:
TH=N*AH
and the Labor Productivity (LP) is:
LP=Y/TH
45
• Then, consider wages. [Note that
differently from neoclassical predictions
in many countries (ex. European
contries) wages are sticky].
• The unit labour cost then is given by:
ULC=W/LP
• (1) when wages go up ULC goes up as
well; (2) when LP goes up ULC goes
down.
46
Identifying CA
Then, consider the relation (1) and use ULC. It
becomes:
ULCC ULCC*

ULCW ULCw*
47
A very simple model
• To have a trend consider growth rates. Take
Natural Logs of our variables. Then, we have:
th  n  ah
lp  y  th
ulc  w  lp
48
Therefore…
Therefore in the short run we easily find that
prices depend upon ULC as:
P  ULC(1  K )
Where K denotes a mark up which in the shot run can be
easily assumed to be constant [especially within
industries]. Then we write simply that:
P  ULC
49
International Competitiveness
To be sold on the world market goods have to be
converted into an international currency. (say
the $).
P  E  ULC
*
Where E denotes the exchange rate between the
home country and the american dollar assumed
to be the international currency. Therefore P* is
the international price of goods to be exported.
Namely a key factor for international
competitiveness
50
Taking natural logs we can easily compute the
growth rate of ULC expressed in dollars. This
is a good proxy for evaluating international
competitiveness.
p  e  ulc
*
Namely, the growth rate of international price of
goods to be exported equals the sum of growth
rate of exchange rate and the growth rate of ULC.
That is, the international competitiveness depends
upon (i) rate of change of exchange rate; (ii)
change of productivity.
51
Labor Productivity and Unit labour
costs
Productivity and Unit Labour Costs in some OECD coutries
growth rates 2000-2005
Productio Employe Average
Hours
n
ment
Italy
-1,2
-0,2
-0.3
Germany
1,7
-1,5
-0,3
France
1,2
-1,8
-0,5
Sweden
3,9
-1,7
-0,2
USA
1,5
-3,7
0,1
Total
Hours
-0,6
-1,8
-2,3
-1,9
-0,3
Hourly
Productiv Hourly
ity
Wages
-0,6
3,1
3,5
2
3,6
3,2
5,9
4,3
5,8
4,6
Unit
Labour exchange ULC in
rate
Costs
dollars
3,7
6,2
10
-1,5
6,2
4,7
-0,4
6,2
5,8
-1,6
4,2
2,7
-1,1
//
-1,1
Source: figures collected from Bureau of Labor Statistics
52
Productivity in OECD countries
(growth rates)
53
EU-15
54
USA
55
56
Sweden
57
Poland
58