1 Trade Facts and Gains From Trade

LecLure 1: Trade FacLs and Cains from Trade
14.581: lnLernaLional Lconomics l

Pol AnLras
Harvard MlT
Spring 2001
Pol AnLras (Harvard MlT} LecLure 1: Trade FacLs and Cains from Trade Spring 2001 1 , 16
Cit e as: Pol Ant ras, course mat erials for 14. 581 I nt ernat ional Economics I , Spring 2007. MI T OpenCourseWare
( ht t p: / / ocw. mit . edu/ ) , Massachuset t s I nst it ut e of Technology. Downloaded on [ DD Mont h YYYY] .
Broad Trade PaLLerns (see HandouL}
Remarkable growLh of world Lrade since WWll. Moreover, Lhe raLio of Lrade
Lo CDP has increased.
NoL a hisLorical conLinuous process. lnLerwar period halLed rsL
globalizaLion during 1810-1914.
Trade in manufacLures has grown parLicularly fasL.
The volume of merchandise Lrade exporLs was 10.2 Lrillion USD in 2005 (10.5
for imporLsll}.
Trade in services has recenLly been expanding rapidly, while share of primary
producLs has been shrinking.
Leading Lraded producLs are compuLers, moLor cars, peLroleum, cloLhing...
Leading exporLers,imporLers are Lhe US, Cermany, China, and Japan (Lhough
noL as % of CDP}.
There exisL sizable diferences in exporLs Lo CDP shares across income
groups: 24% for low-income counLries, 31% for middle-income counLries, and
42% for high-income counLries.
Broad Trade PaLLerns (cLed}
More Lhan 1,2 of world Lrade is among Lhe developed (indusLrial} counLries.
Only 12% among Lhe developing counLries.
Moreover, large share of inLra-indusLry Lrade (generally, over 60%}.
Depending on Lheir income per capiLa, counLries Lend Lo exporL diferenL
Lypes of goods.
CounLries Lend Lo Lrade wiLh neighboring counLries (geography maLLers}.
FragmenLaLion of producLion has been a major facLor in Lhe growLh of Lrade
and FDl.
AbouL 1,3 of world Lrade is inLrarm Lrade.
AL Lhe rm-level, exporLers are in Lhe minoriLy.
ln 1992, only 21% of U.S. planLs reporLed exporLing anyLhing.
LxporLers appear Lo be more producLive (afLer conLrolling for a wide seL of
observables}.
Main QuesLions
The course will ofer some (LenLaLive} answers Lo Lhe following quesLions:
Why do counLries Lrade wiLh each oLher?
Why do Lhey Lrade cerLain producLs raLher Lhan oLhers?
Why do cerLain rms parLicipaLe in inLernaLional Lrade and oLhers do noL?
Why and how are producLion processes fragmenLed across counLries?
How does foreign Lrade afecL naLional economies?
How does iL afecL income of various groups in socieLy?
How do economic growLh and inLernaLional Lrade inLeracL?
ln whaL ways does Lrade respond Lo policies?
WhaL are good Lrade policies?
How are Lrade policies deLermined?
Syllabus
Main parLs of Lhe course:
1
Cains from Trade (briey Loday}
2
SLaLic Neoclassical Models of Trade
1 SLaLic Ricardian Models of Trade
2 SLaLic FacLor ProporLions Models of Trade
3
Lmpirical TesLs of Neoclassical Trade Models
4
New Trade Theory (Scale Lconomies and lmperfecL CompeLiLion}
5
lnLraindusLry HeLerogeneiLy and SelecLion inLo LxporLing
6
MulLinaLional rms and Lhe lnLernaLional OrganizaLion of ProducLion
1
Dynamic lnLernaLional Trade Theory
8
Trade Policy
Time-ermitting we will also cover Trade and lnsLiLuLions, Lconomic
Ceography, and SorLing in Trade and FDl
Cains from Trade: Why do counLries nd iL benecial Lo
Lrade?
Assume:
1
Convex Lechnologies and preferences
2
PerfecL compeLiLion
3
RepresenLaLive individual in each counLry
Theorem
Evc:y ccun:y go|n :cn :oJc.
Proof.
CompeLiLion implies CDP maximizaLion. Therefore p X _ p X
A
, where auLarky
variables include an A superscripL. ln auLarky C
A
X
A
and consumers aLLain a
uLiliLy level u
A
. Using Lhe minimum expendiLure funcLion c
p u
A

min
C
p C [ u C _ u
A
, we have c
p u
A
_ p C
A
p X
A
_ p X
c p u, where Lhe rsL inequaliLy follows from Lhe deniLion of c
p u
A
and Lhe
lasL equaliLy from Lrade balance. BuL c
p u
A
_ c p u = u
A
_ u.
Cains from Trade (conLinued}
We have shown LhaL Lrade will weakly beneL all counLries.
BuL if preferences are sLricLly convex (LhaL is, u is sLricLly quasiconcave},
Lhen Lhe soluLion Lo Lhe LMP is unique, so for p , p
A
, c
p u
A
p C
A
and Lhe gains from Lrade are sLricLly posiLive: u
A
u.
Similarly, if Lhe producLion seL is sLricLly convex, Lhen p X
A
p X and Lhe
gains from Lrade are again sLricLly posiLive: u
A
u.
Cains from Trade: An lllusLraLion
X
X
A
= C
A
C
good 1
good 2
p
1
/p
2
Figure: A Lwo-good example
DisLribuLional AspecLs
Lven Lhough counLries beneL from Lrade, individual consumers may be worse
of (e.g., producers of good 1 in Lhe graph above}.
BuL a simple sysLem of lump-sum Lransfers can ensure LhaL all consumers are
aL leasL as well of (see DixiL and Norman, 1980}.
Consider an economy wiLh | individuals difering in Lheir preferences - dened
over consumpLion and facLor supplies (Lhe laLLer denoLed by v
|
and price w}.
Dene Lhe minimum |um-sum transfer needed Lo achieve uLiliLy u
|A
aL
prices p and w, i.e.,
|

p w u
|A
min
cv
p c w v [ u
|
c v _ u
|A
. (1}
lf consumers receive Lhis Lransfer in Lhe Lrading equilibrium, Lheir welfare is
mainLained aL Lhe auLarky level.
DisLribuLional AspecLs (cLed.}
DenoLing Lhe consumer choices afLer Lrade by c
|
and v
|
, we know from (1}
LhaL
|

p w u
|A
p c
|
w v
|
_ p c
|A
w v
|A
.
LeL V
|
v
o
, C
|
c
o
and noLe LhaL perfecL compeLiLion and CRS imply
0 p X w V _ p X
A
w V
A
.
Now aggregaLing over consumers we have
|

|

p w u
|A
|
c
|
w
|
v
|
|
c
|
X
|
v
|
V
_ p
|
c
|A
X
A
|
v
|A
V
A
C
A
X
A
V
A
V
A
0.
ln sum, a lump-sum Lax sysLem can be designed such LhaL all consumers are
lefL aL leasL as well-of and sLill some money is lefL.
DisLribuLional AspecLs: No Lump-Sum TaxaLion
The above sysLem of lump-sum Lransfer is highly informaLionally inLensive. ln
Lhe presence of privaLe informaLion on preferences, iL will be impossible Lo
implemenL (lC consLrainLs}.
DixiL and Norman (1980, 1986} show how Lo consLrucL a Lrade equilibrium
LhaL PareLo dominaLes Lhe auLarky equilibrium wiLh access Lo only Laxes and
subsidies on goods and facLors.
Suppose Lhe governmenL levies a Lax,subsidy p
A
p on goods and a Lax
w w
A
on facLors. These ensure LhaL consumers face Lhe same prices as in
auLarky, and Lhus make Lhe same choices and aLLain u
|A
.
ls Lax revenue again posiLive? Yesl
P

p
A
p
|
c
|A
w w
A
|
v
|A
p
|
c
|A
w
|
v
|A
p X
A
wV
A
_ p X wV
A
0.
NoLe Lhis is a posiLive resulL, noL a normaLive one.
Basic Law of ComparaLive AdvanLage
NoLe LhaL in Lhe above Lwo-good example, Lhe counLry exporLs Lhe good
(good 2} whose relaLive price wenL up as a resulL of Lrade.
lnLuiLively, counLries gain from Lrade because Lhey exporL goods whose prices
are relaLively higher in Lhe Lrading equilibrium and imporL goods whose prices
are relaLively lower.
ls Lhis posiLive associaLion beLween neL imporLs and auLarky prices robusL?
Yesl
Theorem
Ic M
|
= C
|
X
|
Jcncc |c vccc: c nc |npc: c ccun:y |. T|c c||cw|ng
ccnJ||cn |c|J |n o :cc-:oJc cqu||||:|un:
1
p
A|
M
|
_ 0 c: o|| |;
2
p M
|
0 c: o|| |;
3

|
M
|
0
Basic Law of ComparaLive AdvanLage (cLed.}
Proof.
CondiLions 2 and 3 simply reecL Lrade balance and markeL clearing. As for
condiLion 1, gains from Lrade imply (dropping superscripLs} p
A
C
A
_ p
A
C.
This is because C is preferred Lo C
A
and Lherefore C cannoL be afordable in
auLarky (WARP}. Now from Lhe deniLion of M,
p
A
M p
A
C p
A
X _ p
A
C
A
p
A
X p
A
X
A
p
A
X _ 0,
where Lhe lasL inequaliLy resulLs from Lhe facL LhaL X
A
maximizes CDP in
auLarky.
CondiLion 3 implies LhaL when evaluaLed aL auLarky prices, Lhe value of neL
imporLs of each counLry is negaLive.
Deardorf (1980} derives Lhis formula and shows LhaL iL holds in a general
model LhaL incorporaLes Lrade impedimenLs.
Basic Law of ComparaLive AdvanLage: Lmpirics
Bernhofen and Brown (JPL, 2004} have recenLly provided an empirical
validaLion of Lhis law using hisLorical Japanese daLa from Lhe second half of
Lhe 19Lh cenLury.
ln parLicular, Lhey argue LhaL Japan was preLLy much in auLarky unLil 1859,
when iL opened up Lo Lrade.
Their main idenLifying assumpLion is LhaL one can use auLarky prices from
1851-53 Lo proxy Lhe counLerfacLual auLarky prices in 1868-15.
Their approach is valid as long as auLarky prices would noL have fallen
disproporLionaLely for goods LhaL become imporLables.
They indeed record a posiLive value for Lhe doL producL p
A
M in all years in
1868-15.
Basic Law of ComparaLive AdvanLage: FurLher issues
The basic law of comparaLive advanLage is ofLen wriLLen as follows
p
A|
p
M
|
_ 0 for all |
According Lo Lhis law Lhere is a posiLive associaLion across producLs
beLween Lhe auLarky-Lrade price diference and neL imporLs. On average,
every counLry imporLs (exporLs} goods wiLh auLarky prices relaLively higher
(lower} Lhan Lrading-equilibrium prices.
BuL Lhis is noL a corre|ation. ln order Lo produce one, we can dene Lhe
vecLor of relaLive prices
|
(such LhaL
|
|
p
A|
|
/p
|
for all goods | }, and Lhe
vecLor of Lhe counLry`s neL imporLs valued aL world prices n
|
(wiLh
n
|
|
p
|
M
|
|
for all | }.
Now noLe LhaL using condiLions 1 and 2 we can esLablish:
ccv

|
n
|
p
A|
|
p
|
p
|
M
|
|
1
n
p
A|
|
p
|
p
|
M
|
|

|
p
A|
|
M
|
|
p
A|
M
|
_ 0
Basic Law of ComparaLive AdvanLage: A Useful
NormalizaLion
AlLernaLively, we can normalize prices Lo lie on Lhe uniL simplex:
|
p
|

|
p
A|
|
1 for all |. This is equivalenL Lo xing a bundle of one uniL
of each good as Lhe numeraire.
WiLh Lhis normalizaLion,

|
p
A|
|
p
|
0 and

p
A|
p
M
|
_ 0 imply
LhaL
cc::

p
A|
p M
|
_ 0
ln words, on average counLries imporL goods for which prices fell wiLh Lrade
and exporL goods for which prices increased.
ln Lhe case of Lwo counLries, we can obLain a sharper resulL (only need
auLarky prices}:
cc::

p
A|
p
A|
M
|
_ 0
And wiLh 2 commodiLies and our choice of numeraire,
M
|
|
0 ==p
A|
|
p
A|
|
for | 1 2

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14.581: lnLernaLional Lconomics l

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