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HO model continued: Stolper-Samuelson theorem

HO model continued: Stolper-Samuelson theorem. Readings (All in reader): Ch5 : Factor endowments and HO theory. Salvatore, D. (2) How far does trade with the third world endanger the jobs of low-skilled workers? The Economist 10/1/94, Vol. 333 Issue 7883

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HO model continued: Stolper-Samuelson theorem

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  1. HO model continued:Stolper-Samuelson theorem Readings (All in reader): Ch5 : Factor endowments and HO theory. Salvatore, D. (2) How far does trade with the third world endanger the jobs of low-skilled workers? The Economist 10/1/94, Vol. 333 Issue 7883 (3) Economist; 12/7/96, Vol.341 Issue 7995: Trade and Wages Additional (4) Nicoli Nattrass, 1998. Globalisation and the South African labour market, Trade and Industry Monitor, vol. 6. (5) Lawrence Edwards, 2000. Labour shedding output growth: is trade the culprit? Trade and Industry Monitor , vol. 14.

  2. Summary of FPE Schematic outline of Factor Price Equalization Theorem

  3. FPE After trade: Relative prices converge: US prices of shoes fall with imports from SA SA prices of cars fall with imports from US P*us P*World P*SA

  4. FP Convergence r SK w Factor-Prices in SA (with unemployment?): Fall in demand for K Excess demand for L r0 r1 SL w0 DK1 DL2 DK2 DL1 K L1 L2 L

  5. Stolper-Samuelson Theorem Question: Who benefits from liberalisation and changes in prices? Stolper-Samuelson Theorem: “Free international trade benefits the abundant factor and harms the scarce factor” Or “A rise in the price of a good raises the returns to the factor used intensively in the production of that good, and reduces the return to the other factor”

  6. Summary of S-S theorem Schematic outline of Stolper-Samuelson Theorem

  7. Stolper-Samuelson Theorem But are these real returns? EX in SA: w increases, so welfare of workers who consume cars rise (as Pc falls), but what about those who consume shoes (Psh rises)? In perfect competition: Price of the product is comprised strictly of payments to capital and labour Pgood = cost of labour + cost of capital Remember: w = MPL*P r = MPK*P

  8. (K/L)’1 (K/L)’0 400 shoes 200 shoes 50 cars (K/L)1 100 cars w/r (K/L)0 Why does real return to abundant factor rise? Lets look at SA In response to rising w/r in SA, car and shoe producers substitute labour for capital Cars Shoes K K 80 cars L L Implication? K/L ratio rises in both sectors. What effect does this have on MPL and MPK?

  9. Stolper-Samuelson Theorem Both industries in SA use after FPE relatively more capital than labour: \ MPL & MPK BUT from factor demand equation MPLShoes = w/PShoes MPKShoes = r/PShoes MPLcars = w/Pcars MPKcars = r/Pcars

  10. Stolper-Samuelson Theorem Remember: PSh increased PC decreased MPLS = w / PS MPKS = r / PS MPLC = w / PC MPKC = r / PC Magnification effect in South Africa: %Dw > %DPshoes > %DPcars > %Dr Outcome: real income of abundant factor increased

  11. HO model can also give insight into impact of immigration on an economy

  12. Rybczynski Theorem Rybczynski Theorem: “At constant world prices, if a country experiences an increase in the supply of one factor, it will produce more of the product intensive in that factor and less of the other”

  13. SA PPF and Biased Growth Cars P*world P*world SA is labour abundant Impact of increase of labour force (allow child labour) 100 80 A B 500 700 Shoes

  14. Does Empirical evidence support the HO model?

  15. Limitations of HO predictions Problematic assumptions of HO: Constant technology Demand reversal Factor intensity reversal Transportation cost Imperfect competition Immobile/production specific factors (SFM) These would impact on price ratio (Px/Py) and thus trade pattern

  16. Leontief Paradox USA (1947) relatively capital abundant compared to trading partners. But: Imports were Capital intensive relative to exports! Paradox? Is the HO theorem wrong?

  17. Paradox in SA? SA is a middle income economy and may trade differently with developing and developed economies Table: Revealed relative factor endowments Source: IMF. 2000. South Africa: Selected issues. IMF staff country report No. 00/42. 1. SA is K abundant compared to high, medium and low income countries. 2. SA is unskilled abundant compared to high and medium Y countries 3. SA is skill abundant compared to low Y countries

  18. Employment Flows from Trade, by Education (Bhorat 1999) Figure: Percentage increase in demand for labour from trade, 1990-95 • Trade benefited less skilled during 70’s and early 80’s, but skilled during 90’s

  19. Leontief Paradox Possible explanations: Demand reversal Empirically not supported Factor intensity reversal: Perhaps the imports are produced using labour intensive techniques overseas? Tests show no real significance

  20. Tarrif structure: scarce factor lobbies for protection?- Some relevance but does not fully explain it

  21. Leontief Paradox Possible explanations: Labour not homogenous? There are different skill levels US exports skill-intensive products and imports unskill-intensive products Two-factor model to limited? Only labour-capital distinction too simplistic => need multi-factor model which includes NATURAL RESOURCES

  22. Explanations for Paradox in SA • Capital is internationally mobile and therefore not a determinant of comparative advantage (Adrian Wood) • History of State support for K intensive industries as part of the import substitution programme. State investment (IDC) still biased towards K-intensive sectors • South Africa is a resource intensive economy and exports large quantities of K-intensive non-ferrous metals, iron & steel, minerals. • Export support under the General Export Incentive Scheme (between 1990-96) favoured K-intensive sectors. • Import competition from L-abundant economies such as India and China.

  23. Readings for trade and labour workshop (in reader) QUESTION: Use the HO model to explain rising wage inequality in developed economies in response to trade with developing economies • How far does trade with the third world endanger the jobs of low-skilled workers? The Economist 10/1/94, Vol. 333 Issue 7883 • Economist; 12/7/96, Vol.341 Issue 7995: Trade and Wages Additional • Nicoli Nattrass, 1998. Globalisation and the South African labour market, Trade and Industry Monitor, vol. 6. • Lawrence Edwards, 2000. Labour shedding output growth: is trade the culprit? Trade and Industry Monitor , vol. 14.

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