International Trade Theory and Competitive Models

The following sections are included:

• Dedication
• About the Author
• Contents
• Foreword
• Preface
• Acknowledgements

The Ricardian Model is named after David Ricardo, who, in his book, The Principles of Political Economy and Taxation, (1817), discussed the concept of comparative advantage, a concept that has been fundamental for 200 years in the developments in international trade theory. Chapter 1 is taken from the Supplement to Chapter 5 of the third edition of the textbook, World Trade and Payments, (Richard Caves and Ronald Jones). The supplement was based on my 1961 article, “Comparative Advantage and the Theory of Tariffs: A Multi-Commodity, Multi-Country Model,” published in The Review of Economic Studies, June 1961, (and also appears as Chapter 3 in my 1979 book International Trade: Essays in Theory). The chapter begins by mentioning how the famous concept of comparative advantage was originally formulated in a simple model based on the gains from international trade taking place between two countries, each of them capable of producing two commodities, but with the required labor inputs relatively different between the countries. If each country was better at producing one of the commodities but not the other, it seemed obvious to many that international free trade based upon these assumptions clearly would result in benefits to each country. The Ricardian argument that has been so fundamental to trade theory is that such benefits could be shared by both countries even if labor in one country was better in producing both commodities than the other country. The only requirements for such a mutual gain are that each country would export the commodity in which it possessed a comparative advantage and that goods have a global market but labor (the only input in production) has only a national market (i.e., is not mobile between countries so that wage rates can differ between countries)…

Because the Ricardian trade model has such a simple production structure — each commodity produced only with labor at fixed coefficients — it is ideally suited to the analysis of production assignments in a world with many countries and commodities. The concept of the world transformation schedule provides the focus for our discussion here of comparative advantage in the more general case…

This paper argues that the basic concept of comparative advantage, used in international trade theory to establish choices of commodities exported, can also be used to explain choice of technology by a firm. A firm with a current leading position in a given technology may spurn a new technology, which is developed by a currently lagging firm, leading to future overtaking.

This chapter examines whether a country that enjoys a superior technology in all commodities in a two-country, multi-commodity Ricardian setting could actually gain if its technology in which it possesses its greatest comparative advantage is stolen or transferred to the other country without any compensation. Such a paradoxical possibility is shown always to exist with a finite number of commodities and equal-shared Cobb–Douglas demand conditions for certain ranges of relative country size.

The Ricardian model is especially simple in that production of commodities had a requirement of only a single factor of production, labor. The next major step in international trade theory was to allow more than a single factor, perhaps land, capital, or both, to join labor in theoretical attempts at explaining the wide variety in trade patterns among countries. Eli Heckscher in 1919 and one of his students in Sweden, Bertil Ohlin, in 1933, worked on what became known as the Heckscher–Ohlin model…

The following sections are included:

• Introduction
• The Model
• The Equations of Change
• The Magnification Effect
• The Extended Model: Demand Endogenous
• The Aggregate Elasticity of Substitution
• Convergence to Balanced Growth
• Savings Behavior
• The Analysis of Technological Change
• References

It is a pleasure for me to lead off the panel discussion, a pleasure made double by the fact that it honors two of my former professors—Wolfgang Stolper for my first course in economics at Swarthmore in 1948 and Paul Samuelson at MIT four years later. We are here today to celebrate the 50th anniversary of the appearance of their joint paper, a celebration which by rights should have taken place earlier, and would have if this country’s official house organ, the American Economic Review, had not rejected the piece. It all turned out well in the end, and I frequently cite this rejection to my students to prepare them for the real world…

Few economics articles have achieved the celebrity that still attaches to the paper, “Protection and Real Wages,” by Wolfgang Stolper and Paul Samuelson in (1941). In this chapter, I discuss how the Stolper–Samuelson theorem has been re-interpreted over subsequent decades, and how attempts to generalize the theorem to higher dimensions have met with qualified results. The theorem leads to a simple proposition in political economy: In competitive models any productive factor can have its real return increased by a nontransparent policy whereby relative commodity prices are altered if there are enough commodities and joint production is not too severe.

The famous Leontief paradox compared the factor proportions used in a country’s export sectors with those used in that country’s import-competing sectors in order to conclude whether a country was relatively capital abundant (in a two-factor, labor, and capital setting). When examined in a two-factor, many commodity setting, this procedure reveals the troubling conclusion that as a country’s relative capital endowment rises, its export sector relative to its import-competing sector cycles from being labor-intensive to being capital-intensive, to being labor-intensive, etc., which serves to invalidate the Leontief procedure.

In competitive international trade theory, two of the basic models are the Specific-Factors model and the Heckscher–Ohlin model, with dimensionality 3 × 2 and 2 × 2, respectively. A surprising result in Heckscher–Ohlin is that the effect on factor prices of an infinitesimal change in a commodity price depends neither on the importance of the industry nor on the differences between sectors in the flexibility of technology. For finite price changes, this need no longer be the case, and the model form itself may change endogenously as production patterns get altered. Furthermore, the extent of the response of the wage rate to a price increase in the more labor-intensive commodity becomes less severe the greater is the discrepancy between the degree of labor-intensity difference between sectors in the Heckscher–Ohlin model but more severe in the Specific-Factors model.

“Bubble” diagrams are quite useful in revealing some of the properties found in the competitive models of international trade. These diagrams use circles (bubbles) to indicate commodity outputs and connecting lines to indicate factor inputs. Models such as the 2×2 and n×n Heckscher–Ohlin models as well as the 3×2 (and extensions) Specific-Factors model are discussed. For example, a model with some factor mobility between countries (say capital into a foreign enclave) is discussed for both model types. As well, close analogies are made to issues in labor economics in which both skilled and unskilled labor are used as inputs.

The functional distribution of income can be affected by price changes in international markets, by changes in technology which may be biased in factor saving, and by reductions in cost which allow vertically-integrated production processes to be fragmented and spread over several countries. Simple 2 × 2 Heckscher–Ohlin models yield predictions about income distribution which are at odds with frameworks allowing a wider variety of commodities to be produced and traded. In this framework a country losing out in labor-intensive segment of production to foreign competition may experience increases in real wages.

The role of factor bias in technical progress has been a bone of contention between labor economists and international trade theorists. By considering progress that results in finite changes in techniques these two views can be reconciled. For example, labor-saving technical progress can result in lowered real wages, even if it is concentrated in the more labor-intensive of two commodities initially produced…

Economic models are often judged by the reality of their assumptions or their success at predicting realistic outcomes. In this chapter, I suggest a different criterion for judging models in international trade theory in competitive settings: (i) Does the model conform to common sense in leading to results that even suggest the model is not necessary, and yet (ii) can the same model be used as a tool to reveal in simple terms why certain outcomes that may appear surprising (often labeled a paradox in trade theory) nonetheless are correct. Many trade theory paradoxes appear as the result of income effects in simple general equilibrium models. Here attention centers instead on two of the familiar production models: The Specific-Factors model and the Heckscher–Ohlin model, either separately or when combined. It is shown that very basic properties of production underlie many of the surprising results in competitive trade theory.

Chapter 13 begins with the statement: “The bulk of international trade consists of the exchange of intermediate products, raw materials, and goods which require further local processing before reaching the final consumer.” The first diagram (not Fig. 13.1) suggests why, in the production process, the international trade that takes place between (or among) countries is referred to here as “trade in middle products.” In the early stages of the production process (that we called the Input Tier), local labor and local resources produce goods that enter into the trading process (although some are kept back for use at home) to exchange for other middle products. The array of middle products in the Output Tier of the economy is then joined by local labor further to process the production of final consumption goods to satisfy local consumption demands. The chapter then continues with formal explanations of various elasticities and demand changes. The Appendix adds more formal touches…

The bulk of international trade consists of the exchange of intermediate products, raw materials, and goods which require further local processing before reaching the final consumer. Furthermore, few items in international commerce are pure raw materials or primary factors which have not received any value-added from other local inputs. If production is viewed as a spectrum of activities whereby local primary resources help produce and transform commodities into the final state required by consumers, these observations suggest that international trade takes place in “middle products”…

The following sections are included:

• Introduction
• Services in the Process of Expansion and Fragmentation
• International Markets and the Production Process
• Price Changes and the Role of Services in Trade
• Comparisons with Existing Models
• Concluding Remarks
• References

Much of what has been written about the process of economic development has concentrated on macroeconomic factors that affect the growth process, such as the community’s savings rate, its ability to attract foreign investment, and the composition and quality of its factor-endowment base. Less formally dealt with, but nonetheless often cited as important in the development process, is the nature of government regulations and the type of institutions that are reflective of the community’s own cultural inheritance…

The New Economic Geography, as expounded by Krugman and others, highlights the importance of greater extent of agglomeration as incomes grow in the world economy. In this chapter, we suggest an alternative framework in which, as incomes grow, greater degrees of economic fragmentation, and disagglomeration are encouraged. In both approaches increasing returns to scale are crucial, but in ours these are found in service sectors that allow separate production blocks to be coordinated instead of being found within separate production blocks.

Fragmentation of vertically integrated production processes implies that segments (production blocks) are located in different geographical areas, perhaps in different countries, and that they may be undertaken by different firms. Service links are required to coordinate such fragmentation, and it is in these links (such as communication and transportation) that significant economies of scale are to be found. This often leads to dis-agglomeration of economic activity, especially at the international level, which runs counter to suggestions found in the “new economic geography” literature. This paper explores the implications of increasing returns in service links for fragmentation and the dispersion of production.

Part IV consists of Chapters 18 and 19. Each of them appeared in publications in 2015. Chapter 18 focuses on a number of features of small-scale general equilibrium models that are used in international trade theory. Not surprisingly, the first such model is the Ricardian model, discussed in Part 1 of this book. As well there are subjects not treated earlier in the book, such as the stability issues in models, the transfer problem and the Reciprocity Theorem. As the title of the chapter suggests, models that specifically are limited to dealing with small numbers of commodities, factors, and countries often reveal properties that can be found in models that are not so limited but are, therefore, more difficult to analyze…

The field of international economics has made frequent use of general equilibrium models in order to investigate the nature of those possible comparative static equilibrium solutions that seem somewhat paradoxica1. Frequently the analysis is done for settings in which the number of commodities, countries, and/or factors of production is assumed to be rather small. For example, the Classic Ricardian model making use of the concept of comparative advantage based on comparisons of efficient ratios of country productivities has solutions that hold for any number of countries or commodities. A number of different issues, such as stability conditions and the transfer problem, are discussed in which surprising equilibrium outcomes possible in a general situation can be understood more easily in a small-scale setting.

Three standard models typically discussed in the theory of international trade are the Ricardian model, the Heckscher–Ohlin model and the Specific-Factors model. Models are often compared with each other, in an attempt to analyze which model is best or fits reality better. Instead, I suggest that these international trade models can often be blended to take account of finite changes when, as a country develops, the appropriate model to be used changes as the pattern of production changes. Trade allows countries to produce fewer commodities than it consumes, and which commodities are selected to be produced may change as the economy grows in the size of its endowment bundle and/or technology changes. At issue is not only the question of which commodities are produced, but also how many commodities are produced, especially with reference to the number of productive factors.