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Interregional Trade

Interregional Trade. Lecture 8 Last lecture: - Industrial Location Theory This lecture: - Interregional Trade Aim: To discover why regions specialise in certain commodities Outcomes: Awareness of Ricardian and Heckscher-Ohlin theories of regional trade

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Interregional Trade

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  1. Interregional Trade Regional and Local Economics (RALE) Lecture slides – Lecture 4b

  2. Lecture 8 Last lecture: - Industrial Location Theory This lecture: - Interregional Trade Aim: • To discover why regions specialise in certain commodities Outcomes: • Awareness of Ricardian and Heckscher-Ohlin theories of regional trade • Awareness of more radical explanations of regional trade and specialisation Regional and Local Economics (RALE) Lecture slides – Lecture 4b

  3. Proposition - Regions need to trade if they are to be prosperous. • All regions are becoming more “open” EU, GATT. Proportion of goods and services % GDP exported imported Luxembourg 93% 80% Belgium 75% 69% Greece 16% 24% • Success breeds Success. Regional and Local Economics (RALE) Lecture slides – Lecture 4b

  4. Ricardian Trade Theory - regions can gain from trade by specialising in production and export of goods in which they have a “comparative advantage” • Possibility of mutually advantageous gains from trade. • Exchange rate cars for wheat South 1:5 North 1:7 if world rate settles at 1:6 • South exchanges one car for 6 tonnes of wheat can only get 5 tonnes at home • North imports car for 6 tonnes of wheat but cost of home produced is 7 tonnes Regional and Local Economic Analysis (RALE) Lecture slides – Lecture 8

  5. Question - what is the source of comparative advantage? • Labour productivity (is this realistic?) • Technology or capital stock? • Could it be wages? Regional and Local Economics (RALE) Lecture slides – Lecture 4b

  6. P of labour/ price of capital F cs F cn Wheat 1 unit Cars 1 unit R cn R cs R ws R wn Ratio of labour to capital L/K Heckscher- Ohlin Trade Theorem • Simple version only two factors of production K and L. • Comparative advantage from initial factor endowment each region specialising in its rich factor. • capital abundance in south leads to car production • Labour abundance in north leads to wheat production. Adapted from Armstrong and Taylor (2000) pp 125 Regional and Local Economics (RALE) Lecture slides – Lecture 4b

  7. Adapted from Armstrong and Taylor (2000) pp 125 • Prediction • South has an advantage in producing cars because it uses a lot of its cheaper factor (capital) • North has advantage in Wheat because it uses a lot of its cheaper factor (Labour) • The difference in the price ratios creates the opportunity for trade Regional and Local Economic Analysis (RALE) Lecture slides – Lecture 8

  8. Restrictive assumptions • There are only two factors of production – labour and capital • Factors of production are of the same quality in both regions • Each region’s endowments of capital and labour are fixed • Production functions are the same in each region (no regional advantage from superior technology) • Production functions have constant returns to scale • There is perfect competition in each region’s factor and commodity markets • Trade is free of all obstructions (tariffs etc.) • There is strong factor intensity at all sets of factor prices • Tastes are identical in all regions and do not vary with regional income levels Regional and Local Economics (RALE) Lecture slides – Lecture 4b

  9. Relaxing the assumption of fixed factor endowment • More than two factors of production • Factor quality (human capital) • Strong factor intensities • Constant returns to scale • Factor migration Adapted from Armstrong and Taylor (2000) pp 130 Regional and Local Economics (RALE) Lecture slides – Lecture 4b

  10. Intra-industry trade theory (exchange of virtually identical products) Horizontal • Wide range of choice may loose share in domestic market but openings in export markets • Need high levels of output, economies of scale • Highest in closely integrated economies Vertical • In same industry but at different stages in the production chain Regional and Local Economics (RALE) Lecture slides – Lecture 4b

  11. Competitive Advantage • Mutually reinforcing competitive advantage • Importance of interactions between elements • Not a formalised model but draws on case studies - not all regions will have all elements “in place”. Adapted from Armstrong and Taylor (2000) pp 133 Regional and Local Economics (RALE) Lecture slides – Lecture 4b

  12. Centripetal forces Market-size Thick Labour market External economies Centrifugal forces Immobile factors Land rents External diseconomies See Krugman 1998 New Economic Geography • Home market effect • Footloose labour/industries model • Vertically linked industries model Regional and Local Economics (RALE) Lecture slides – Lecture 4b

  13. Conclusions - Why specialisation exists • Ricardian opportunity cost advantage creates climate for trade. • Heckschler-Ohlin theorem predicts local factor abundance as the reason for regional specialisation • Intra-industry trade models explain observed behaviour • Geography still matters. Next Week Inter-regional Labour Migration Regional and Local Economics (RALE) Lecture slides – Lecture 4b

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