Comparative Advantage, Growth, and the Gains from Trade and Globalization

The following sections are included:

• PREFACE AND ACKNOWLEDGMENTS

• TABLE OF CONTENTS

• FESTSCHRIFT PANELISTS

• INTRODUCTION

For years, the University of Michigan, as well as its colleges, schools, and departments, operated under the policy best described by Senator Moynihan as one of “benign neglect” toward its alumni. As a result, I had little contact with the College of LS&A, the Rackham School, or the Department of Economics from which I received both my bachelor's and master's degrees in the late '50s…

The following sections are included:

• INTRODUCTION

• REFLECTIONS ON GLOBALIZATION: YESTERDAY AND TODAY

Alphabetical order puts me at the head of a distinguished panel with far more authority than I to speak on the subject of comparative advantage. I will be appropriately brief. But perhaps my perspective as a consumer rather than as a producer here will be useful.

In my opinion the writings of Alan Deardorff on comparative advantage are a great example of progress in economic theory and its connection to empirical confirmation. Almost 30 years later, it seems like we have always known these ideas. Appreciating the greatness of his 1980 and 1982 papers requires recalling the scene in which they appeared…

It is a special pleasure and privilege for me to be speaking at Alan Deardorff's 65th birthday celebration, and on the subject of comparative advantage. We have close connections in both respects. We were born only two days apart — he on D-day, and I on D + 2. And for a while we worked along closely parallel lines, albeit in total ignorance of each other's work. I still remember the pleasure I felt when I discovered his papers on generalizing comparative advantage: the fact that someone deeply immersed in the traditions of international trade had independently thought it useful to reformulate the question in the same way, and proceed to develop the theory very similarly, was comforting to Victor Norman and me, who were relative amateurs bumbling into the field…

We are here to praise Alan Deardorff — hopefully not yet to bury him. This is a delightful task (the praise, I mean), and not just because of his accomplishments, which I'll get to in a minute, but because Alan is one of the truly kind and decent people in our profession, and I feel privileged to have known him over these many years…

The following sections are included:

• THE TWO-COMMODITY CASE

• FACTOR INTENSITY REVERSAL IN TECHNOLOGY

• CONES IN THE MULTI-COMMODITY SETTING

• CONCLUDING REMARKS: THE SIGNIFICANCE OF CONES OF DIVERSIFICATION

• REFERENCES

The following sections are included:

• THE OLD NEW TRADE STORY

• COLLARS AND CUFFS, BUTTONS AND CIGARETTE LIGHTERS

• LOCALIZED EXTERNAL ECONOMIES AND THE GAINS FROM TRADE

• REFERENCES

It is a huge pleasure to contribute to this happy event. I have known Alan Deardorff for over 30 years and have enjoyed his company and savored his insights on countless occasions. He is not just a great scholar, but also a great guy, an indefatigable champion of the field of international trade, and a disinterested provider of public goods. We are all in his debt for his web resources, useful as well as fun, that shine like a good deed in a naughty world, or, to push the public goods analogy further, like a lighthouse towering over shark infested seas. (I will refrain from naming any sharks.) Of course, we are also in his debt for his scholarship, and I want to make some remarks today inspired by rereading his classic papers on generalizing the theory of comparative advantage and the Heckscher-Ohlin theorem…

This paper examines the proposition that trade in many commodities can be explained by a chain of comparative advantage. It is first shown, in a two-country, two-factor model, that trade accords with the ranking of goods by factor intensity if there are unequal factor prices, free trade, and only final goods. This result continues to hold if either trade impediments or intermediate products are introduced. However, if both are present, the chain proposition breaks down. Finally, with many countries, it is shown that trade impediments alone can invalidate the chain proposition.

It is well known that the law of comparative advantage breaks down when applied to individual commodities or pairs of commodities in a many-commodity world. This paper shows that the law is nonetheless valid if restated in terms of averages across all commodities. Specifically, a theorem and several corollaries are derived which establish correlations between vectors of trade and vectors containing relative-autarky-price measures of comparative advantage. These results are proven in a general many-commodity model that allows for tariffs, transport costs, and other impediments to trade.

The following sections are included:

• Assumptions

• The Factor Content of Trade

• A Theorem on the Factor Content of Trade

• Implication for the Pattern of Factor-Content Trade

• Implications for the Pattern of Commodity Trade

• Factor Intensity Ambiguities

• REFERENCES

The following sections are included:

• TRADE IN TRADE SERVICES

• SERVICES TRADE AS INTERNATIONAL FACTOR MOVEMENTS

• SERVICE TRADE WITH ABSENT FACTORS
  • Case I: Services are management intensive
  • Case II: Services are labour intensive
  • Case III: Differences in technology
  • Summary of the cases

• CONCLUSION

• REFERENCES

An example is presented of a two-country, two-factor, four-good trade model in which free trade causes factor prices to be drawn farther apart than they were in autarky. The example is equivalent to a two-good model with a double factor intensity reversal (FIR), and thus demonstrates that the problems associated with FIRs can arise in many dimensions without them. These problems include the undermining of other trade theorems as well, and can be avoided only by making some assumption about demand as well as about technology. For example, the model becomes well-behaved if preferences and technology are both Cobb-Douglas.

This paper explores the implications for the pattern of international trade of differences among regions within countries—what we call “lumpiness.” If factors of production are sufficiently unevenly distributed across regions, then the pattern of trade of the country as a whole may depart from what it would have been had factors been evenly distributed. Thus lumpiness in the geographical distribution of factors can be a determinant of trade. We show in particular that if other determinants of trade are absent, then a country will tend to export the good that intensively uses its lumpier (i.e., more unevenly distributed) factor.

This paper derives a condition for factor price equalization (FPE) in a Heckscher–Ohlin model with many goods, factors, and countries. Using Dixit and Norman's integrated world economy (IWE), two sets, called lenses, are constructed: one spanned by the factor vectors used to produce goods in the IWE; the other spanned by the countries' factor endowments. If the factor-endowment lens ever passes outside the factor-use lens, then FPE is impossible. In this sense, therefore, FPE requires that factor endowments vary less across countries than factor intensities vary across industries.

This paper examines the effects of “fragmentation,” defined as the splitting of a production process into two or more steps that can be undertaken in different locations but that lead to the same final product. Introducing the possibility of fragmentation into simple theoretical models of international trade, the paper finds the effects of fragmentation on national welfare, on patterns of specialization and trade, and on factor prices. Models examined include the Ricardian Model and the Heckscher-Ohlin Model, both for small open economies and for a two-country world. Results are as follows: 1. If fragmentation does not change the prices of goods, then it must increase the value of output of any country where it occurs and that of the world. 2. If fragmentation does change prices, then fragmentation can lower the welfare of a country by turning its terms of trade against it. 3. Even in a country that gains from fragmentation, it is possible (but not necessary) that some factor owners within that country will lose. 4. To the extent that factor prices are not equalized internationally in the absence of fragmentation, fragmentation may be a force toward factor price equalization. © 2001 Elsevier Science Inc. All rights reserved.

This paper reviews the theoretical development of the concept of comparative advantage, starting with the two-good model of Ricardo and the two-good extension and reinterpretation by Haberler. In both, the presence of comparative advantage provides the scope for countries to gain from trade by specializing, and the pattern of that trade is explained by the pattern of comparative advantage. These strong results of the two-good model can be extended under certain circumstances to multiple goods and countries, but under more general assumptions such strong results no longer are assured. Instead one can derive much weaker results, usually in the form of correlations between comparative advantage and trade, and these weaker results hold in a much wider variety of circumstances. The paper examines those assumptions that permit such generalizations, but then also examines when those assumptions are most likely to fail, and what happens as a result.

It has been a pleasure to re-read some of Alan Deardorff's papers on trade and growth, and to read others for the first time. These papers are typical of Alan's work; they artfully tease new insights on important issues from simple, familiar models.

It is fitting to begin my review with “A Geometry of Growth and Trade.” Alan loves diagrams, and given his skill in developing them, it is easy to see why. His diagrammatic analyses are as incisive as any algebraic treatment and more pleasing to the eye…

I am pleased and honored to participate in this celebration of Alan Deardorff. He has contributed enormously to the profession through his research, his teaching, his policy contributions, and his good citizenship in the profession. I won't comment on his teaching and good citizenship except to say that I've encountered many of Alan's former students, both graduate and undergraduate, and all speak enthusiastically about his support and role in their education, including in some cases their decision to go on to graduate school in economics. And many of his former students, who are participating in this symposium, have continued down paths opened up by Alan and, of course, his colleagues…

Let me begin by saluting Alan Deardorff for his enormous contributions to trade theory per se and importantly to parts of theory that have served as formulations for empirical analysis. There are many I could cite from his large body of work. I will cite just three: Alan Deardorff (1998) is among those which provided a theoretical foundation for the workhorse of empirical analysis of bilateral trade flows, namely the gravity model that goes back to Jan Tinbergen (1962) and Hans Linneman (1966) of the Tinbergen School. The others are his classic papers on the general validity of comparative advantage, one (Deardorff, 1980) based on the Ricardian model and the other (Deardorff, 1982) based on Heckscher–Ohlin–Samuelson (HOS)…

The following sections are included:

• The closed economy

• The open economy

• The possibility of gains and losses from trade

• Trade generated by different savings propensities

• Trade generated by different technologies

• The case of the capital-intensive investment good

• The adjustment towards steady state
  • Initially in steady state
  • Not initially in steady state

• Conclusion

• REFERENCES

The following sections are included:

• INTRODUCTION

• THE DIAGRAM

• GROWTH IN THE SMALL OPEN ECONOMY

• OTHER APPLICATIONS

• REFERENCES

The following sections are included:

• Introduction

• The small country case

• The two-country case

• Implications for two-class growth models

• ACKNOWLEDGEMENTS

• REFERENCES

This paper derives equations for the value of bilateral trade from two extreme cases of the Heckscher-Ohlin Model, both of which could also represent a variety of other models as well. The first case is frictionless trade, in which the absence of all impediments to trade in homogeneous products causes producers and consumers to be indifferent among trading partners. Resolving this indifference randomly, expected trade flows correspond exactly to the simple frictionless gravity equation if preferences are identical and homothetic or if demands are uncorrelated with supplies, and they depart from that equation systematically when there are such correlations. The second case is of countries that each produce distinct goods, as in the H-O Model with complete specialization or a variety of other models. Expressions are derived for bilateral trade, first with Cobb-Douglas preferences and then with CES preferences. The standard gravity equation with trade declining in distance continues to be a central tendency for these trade flows, with departures from it that are easily understood in terms of relative transport costs. The main lessons from the paper are two. First, it is not all that difficult to justify even simple forms of the gravity equation from standard trade theories. Second, because the gravity equation appears to characterize a large class of models, its use for empirical tests of any of them is suspect.

A neoclassical growth model provides an explanation for a ‘poverty trap’, ‘club convergence’, or ‘twin peaks’, in terms of specialisation and international trade. The model has many countries with identical linearly homogeneous technologies for producing three goods using capital and labour. With diverse initial endowments, initial equilibrium has unequal factor prices and two diversification cones. With savings out of wages, following Galor (1996), there may easily be multiple steady states. Poor countries converge to a low steady state while rich countries converge to a high one, even though all share identical technological and behavioural parameters.

It is an honor to participate in a Festschrift for Alan Deardorff. Alan is a master theorist. He has made major contributions to our understanding of so many economic concepts and relationships in international economics with his modeling and analytical skills. Moreover, he has done so in an exceptionally clear manner, often using geometry as well as algebra to make his points.

The following sections are included:

• DEVELOPED COUNTRY PROTECTION AND SUBSIDIES IN AGRICULTURE

• INTELLECTUAL PROPERTY RIGHTS, LABOR STANDARDS AND RULE MAKING

• THIRD-COUNTRY EFFECTS OF TRADE LIBERALIZATION

• CORPORATIONS AND GLOBALIZATION

• REFERENCES

This paper uses a simple model of invention and patent protection to examine the welfare effects of extending patent protection from the country where invention takes place to another country that is only a consumer of invented products. It is shown that, while the welfare of the inventing country certainly rises with the extension of patent protection, that of the other country probably falls, and may well fall by more than the increase in welfare of the inventing country. In particular, as patent protection is extended to a larger and larger portion of the world, the effect on the welfare of the world as a whole of extending it to the rest of the world becomes negative.

This paper examines the effects on welfare and on patterns of trade of a reduction in costs of trading, such as might be the result of newly formed networks among residents of different countries with common culture or other ties. It argues that such a reduction in trade costs, even when it applies only to a particular bilateral trade route and may cause imports to be diverted from one source to another, must in the absence of distortions be welfare improving in the aggregate. On the other hand, such a change can indeed alter trade patterns distinctly, and they may also lower the welfare of particular countries. Examples are provided in which falling trade costs cause reversals of a country's pattern of trade, and in which a country that becomes part of a trade-cost-reducing network that alters its trade loses as a result.

The following sections are included:

• INTRODUCTION

• THE CRITICS' MODELS

• CONCLUSION

• REFERENCES

This paper uses trade theory to examine the effects of trade liberalization on countries that do not participate in it. These include both countries that fail to participate in multilateral trade negotiations, and also countries that lie outside of preferential trading arrangements such as free trade areas. The analysis suggests that, while it is theoretically possible for excluded countries to gain from trade liberalization through improved terms of trade, several reasons suggest that they are more likely to lose.

© 2006 Elsevier Ltd. All rights reserved.

In this paper I argue that profit maximizing firms, even though they contribute to social welfare when they compete in the market, may not do so when they influence the political process. In particular, I suggest, through several examples from both the real world and from economic theory, that corporations have played a significant role in the formulation of the rules of the international trading system. They did this in the formation of the WTO, where they were responsible for the expansion to cover both intellectual property and services. And they do this in preferential trading arrangements such as the NAFTA, where they inserted the notorious Chapter 11 and specified rules of origin for automotive products. All of this is quite consistent with economic theory, including the literature on the political economy of trade policy. I also use a simple duopoly model to illustrate a domestic firm's interest in setting rules of origin. The corporate influence on rules need not be bad, but there is no reason why it should be good either, as these examples illustrate.

The following sections are included:

• THE PLANNING-FEEDBACK APPROACH TO COMPUTATIONAL TRADE MODELING

• OTHER IMPORTANT CONTRIBUTIONS

• FUTURE DIRECTIONS FOR COMPUTATIONAL ANALYSIS OF INTERNATIONAL TRADE

• REFERENCES

The following sections are included:

• THE THIRD WAY

• LIMITATIONS OF TRADITIONAL ANALYTICAL THEORY

• DISCONNECT BETWEEN AGE MODELING AND ECONOMETRICS

• ACKNOWLEDGMENT OF EARLY CONTRIBUTORS TO THE DEVELOPMENT OF SIMULATION MODELING

• NATTERING NABOBS OF NEGATIVITY

• WAYS FORWARD?

• CONCLUSIONS

• REFERENCES

It's a pleasure to have the opportunity to comment on Alan's work on computational modeling and trade policy analysis. Alan came to this field from highbrow economic theory, where he made particularly important contributions on esoteric theoretical issues such as cones of diversification. From this background, he and his collaborators made major practical contributions to helping build support for some of the most important and far-reaching agreements — including the Tokyo Round of the GATT; the Uruguay Round of the GATT/WTO, and the North American Free Trade Agreement. Alan's applied studies took into account many of the mind numbing details of these agreements, and incorporated new developments — such as services — where the data were poor and even the theoretical basis for analysis needed to be developed from scratch. This contribution by a leading theorist to influential analyses of applied policies is very unusual, and deserves high praise.

The following sections are included:

• Theoretical Structure of the Model

• Overview of the Model

• Equations of the Model

• Country-system equations

• World-system equations

• Supply and Demand Functions

• The Armington Assumption

• Nontariff Barriers

• Import Licensing

• Rest-of-World Net Supply

• Departures from General Equilibrium

• Economic Welfare

• Theoretical Illustrations of the Model

• The Closure Issue

• Comparison with Other Computational Models

• Experience from the Michigan Model and Implications for Research

• Lessons from Computer Modeling of Trade
  • Methodology
  • The Armington Assumption
  • Tariff Revenue Redistribution
  • Import Licensing
  • Tariffs

• Directions for Future Research

• Notes

• References

The following sections are included:

• Description of the Model

• Conceptual Framework
  • Exogeneity of Tariff-Exclusive Prices
  • Exogeneity of Exchange Rates
  • Exogeneity of Foreign Tariffs
  • Traded versus Nontraded Goods

• Data

• Results
  • Alternative Measures of CPVA
  • Explanations of the Pattern of Changes in Tariffs and Protection
  • Indicators of Resource Pull Effects of Protection
  • Further Comparison of the Pre- and Post-Tokyo Round Structure of Protection
  • The Terms of Trade of the Major Developing Countries

• Conclusion

• Appendix Equations of the Model

• Notes

• References

This paper shows that the factor content of trade can be used to indicate effects of trade on relative factor prices. Factor prices in two trading equilibria can be compared by comparing instead their two ‘equivalent autarky equilibria’ constructed by changing factor endowments by the factor content of trade. Using relationships between autarky factor prices and factor endowments, several relationships are derived between factor prices with trade and its factor content. The most general result is a positive correlation between relative changes in the factor content of trade, appropriately normalized, and proportional changes in factor prices.

Data on pre-Tokyo Round tariffs and ad valorem approximations of non tariff barriers are used in the Michigan Computational Model of World Production and Trade to calculate changes in commodity trade attributable to protection in Japan and the United States. Data on factor requirements in production are then used to calculate the factor contents of these computed changes in trade. Results indicate that Japanese protection is more distortionary of factor markets in Japan and the United States than is American protection, and that U.S. manufacturing labor would be the least likely to gain from trade liberalization in Japan and/or the United States.

The following sections are included:

• INTRODUCTION

• ISSUES IN ANALYSING THE ECONOMIC IMPACT OF THE NAFTA

• THE COMPUTATIONAL MODEL

• COMPUTATIONAL RESULTS

• CONCLUSIONS

• REFERENCES

The following sections are included:

• Introduction

• A Theoretical Framework

• Economic Linkages between Tariffs and Real Wages

• Description of the Michigan NAFTA Model

• Adaptation of the Theory to the Michigan NAFTA Model

• Real Wage Effects in NAFT A Scenarios

• Conclusion

• References

• APPENDIX The Michigan NAFT A Model: Equation, Notation, and Explanation

The following sections are included:

• A description of the analytical model
  • Assumptions underlying the model
  • Full employment
  • Balanced trade
  • Rents and revenues
  • Fixed relative wages
  • Fixed labor supply

• Policy input data: comments on reductions in tariffs and tariff equivalents
  • Tariff rates on industrial products
  • Tariff rates on agricultural products

• Services-trade barriers

• Model simulations
  • Simulation 1
  • Simulation 2
  • Simulation 3

• Aggregate impacts of the three liberalization scenarios
  • Economic welfare
  • Real wages and return to capital

• Sector-specific impacts of the three liberalization scenarios

• Simulation 1

• Simulation 2

• Simulation 3

• Appendix A Developing data on “tradable” services

• Notes

• References

The following sections are included:

• General Methods for Measuring the Presence or Size of NTBs
  • Frequency-Type Measures
  • Price-Comparison Measures
  • Quantity-Impact Measures
  • Special Purpose Methods

• NTB-Specific Methods for Selected NTBs
  • Quotas
  • Variable Levies
  • Voluntary Export Restraints
  • Government Procurement Regulations
  • Domestic Subsidies
  • Domestic Content Requirements
  • Antidumping and Countervailing Duty Measures
  • Customs Valuation Procedures
  • Technical Barriers to Trade
  • Conclusion

• General Methods for Measuring the Effects of NTBs

• Effective Rates of Protection (ERPs) and Effective Rates of Assistance (ERAs)
  • Trade Restrictiveness Index (TRI)
  • Applied General Equilibrium (AGE) Model Measures

• Notes to Chapter 3

• APPENDIX 3 Formulas for Measuring NTBs

• Notes