3 - Productivity and Trade

Question 1

Who created the concept of ‘comparative advantage’ to point out the pattern and benefits of international trade?

Answer 1

David Ricardo in the early 19th century, He was a British Economist

Question 2

In Ricardo’s model of comparative advantage, what was international trade solely due to?

Answer 2

International differences in the ‘productivity of labour’

Question 3

What are differences in productivity usually explained by?

Answer 3

Explained by differences in technology

Question 4

What 2 concepts does Ricardo’s comparative advantage model use?

Answer 4

‘Opportunity cost’ and ‘comparative advantage’

Question 5

What is ‘opportunity cost’?

Answer 5

The opportunity cost of producing something measures the cost of not being able to produce something else because resources have already been used

Question 6

When does a country face opportunity costs?

Answer 6

When it employs resourves to produce goods and services

Question 7

Briefly explain the tradeoff between cars and computers?

Answer 7

A limited number of workers could be employed to produce either cars of computers - then the opportunity cost of producing computers is the number of cars not produced and vice versa when producing cars. The country faces a trade-off: how many computers or cars should it produce with the limited resources it has

Question 8

When does a country have a comparative advantage?

Answer 8

If the opportunity cost of producing that good is lower in the country than it is in other countries. A country with a comparative advantage in producing a good uses it resources most efficiently when it produces that good compared to producing other goods

Question 9

What are the 3 empirical studies that we look at?

Answer 9

• MacDougall (1951/52)
• Golub & Hsieh (2000)
• Costinot et al (2012)

Question 10

What did MacDougall (1951/52) use to test the Ricardian trade model?

Answer 10

MacDougall used labour productivity and export data for 25 industries in the US and the UK for 1937

Question 11

What was MacDougall’s (1951/52) argument?

Answer 11

Since wages were twice as high in the US as in the UK, he argued that costs of production in the US in those industries where American labour was more than twice as productive as British labour. These would be the industries in which the US had a comparative advantage and would undersell the UK in third markets

Question 12

What would happen in industries where Britain had a comparative advantage?

Answer 12

The UK would undersell the US in those industries where the productivity of British labour was more than one-half of American labour

Question 13

What did MacDougall (1951/52) adjust for in his analysis?

Answer 13

Adjusted for the effects of US and UK tariffs because they varied widely from industry to industry, tending to offset the differences in labour productivity between the two countries. At the same time, both countries faced generally equal tariffs in third markets

Question 14

What does the MacDougall’s (1951/52) graph show?

Answer 14

• There is a clear positive relationship between labour productivity and exports
• Those industries where the productivity of labour is relatively higher in the US than in the UK are the industries with the higher ratios of US to UK exports

Question 15

What countries did Gloub & Hsieh (2000) test for in comparison with the US?

Answer 15

Japan, Germany, France, UK, Italy, Canada, Australia, South Korea and Mexico

Question 15

What was MacDougall’s (1951/52) conclusion?

Answer 15

• Those industries where the productivity of labour is relatively higher in the US than in the UK are the industries with the higher ratios of US to UK exports
• Thus, the study supports the Ricardian theory of comparative advantage
• The actual pattern of trade seems to be based on the different labour productivities in different industries in two countries

Question 16

For each of the bilateral trade pairs with the US, what two alternative measures of trade flows did Golub & Hsieh (2000) use?

Answer 16

• Bilateral trade balances
• Export ratios

Question 17

How did Golub & Hsieh (2000) use data?

Answer 17

• Data covers 1970-72, all variables are in logs, the explanatory variable was lagged one year to allow for slow adjustment

Question 18

What were the dependent and independent variables in the Golub & Hsieh (2000) regression?

Answer 18

• Dependent: Relative exports
• Independent: Relative productivity

Question 19

What did Golub & Hsieh’s (2000) study show?

Answer 19

The coefficient were positive and statistically significant, showing that when the US had higher relative productivity than the other country, it had higher exports relative to that country, which is the expected result and supports Ricardo’s theory

Question 20

What to higher unit labour costs lead to according to Golub & Hsieh (2000)?

Answer 20

Higher unit labour costs are expected to lead to lower trade balances

Question 21

What data did Costinot et al (2012) use to test the Ricardian model?

Answer 21

Used data from 1997 covering 21 countries (18 in Europe + Japan, South Korea and US)

Question 22

What did Costinot et al. (2012) use as the dependent variable?

Answer 22

The value of bilateral exports from each of these 21 countries to each of these 21 countries in each industry

Question 23

How did Costinot et al. (2012) adjusted the dependent variable of bilateral exports of each country to each country in each industry?

Answer 23

• Costinot et al. (2012) adjusted this measure by additinally taking into account how much each exporting country imports in each industry relative to its total expenditure in that industry
• In this way, they adjust for differences in levels of “openness” to account for “trade-driven selection”

Question 24

What did Costinot et al. (2012) use as the explanatory variable?

Answer 24

They measured variation in productivity across countrues and industries using differences in producer price indices

Question 25

What was the regression analysis of Costinot et al. (2012)?

Answer 25

- They used an instrumental variable to account for possible endogeneity of productivity - For example, higher export levels may lead to higher productivity (reverse causality bias) - Using an instrumental variable enables them to estimate the causal effect of productivity on exports, rather than the other way around - Costinot et al. instrument their productivity variable with R&D expenditures at the country-industry level - They also control for exporter-import and importer-industry fixed effects - In an additional empirical exercise, they estimate the effect of Ricardian comparative advantage

Question 26

What were the results from the Costinot et al. (2012) study?

Answer 26

- All else equal, the elasticity of (adjusted) bilateral exports with respect to observed productivity is positive, equal to 6.5 - This is what the Ricardian model predicts - According to welfare estimates, the removal of Ricardian comparative advantage at the industry level would lead, on average across countries, to a 5.3% decrease in the total gains from trade

Question 27

What does a positive elasticity mean?

Answer 27

- A positive elasticity indicates that as a country’s productivity in a given sector increases, its exports to a trading partner in that sector also increase. - When observed productivity (e.g., output per worker) in a specific industry rises, the bilateral exports (exports from one country to another) in that industry also tend to rise

Question 27

What are the 2 reasons countries engage in international trade?

Answer 27

1 - they are different from each other and can benefit from their differences by reaching an arrangement in which each does the things it does relatively well 2 - countries trade to achieve economies of scale in production - if each country produces only a limited range of goods, it can produce each of these goods at a larger scale and hence more efficiently than if it tried to produce everything

Question 28

Why is "free trade is beneficial only if your country is strong enough to stand up to competition" a myth?

Answer 28

- A well-known historian once said: "what if there is nothing you can produce more cheaply or efficiently than anywhere else, except by constantly cutting labour costs"? - This fails to understand the essential point of Ricardo's model - that gains from trade depend on comparative advantage rather than absolute advantage - UK is less efficient than France in manufacturing wine, but it is at an even greater relative productivity disadvantage in cheese. Because of its lower overall productivity, the UK pays lower wages than France, sufficiently lower that it ends up with lower costs in wine production

Question 29

Why is "foreign competitiion is unfair and hurts other countries when it is based on low wages" a myth?

Answer 29

- This is a favoured argument of labour unions seeking protection from foreign competition - People who adhere to this believe argue that industries shouldn't have to cope with coreign industries that are less efficient but pay lower wages - France is more productive than the UK in both industries, and UK's lower cost of wine production is entirely due to its much lower wage rate - UK's lower wages rate is irrelevant in whether France gains form trade. Whether the lower cost of wine produced in UK is due to high productivity doesn't matter. All that matters to France is that it is cheaper in terms of its own labour for France to produce cheese and trade it for wine than produce wine for itself

Question 30

Going back to MacDougall (1952), in how many of the 26 sectors did the US exceed British productivity and in how many did Britain actually have larger exports than the US?

Answer 30

- US productivity was higher in all 26 sectors - In 12 of the sectors Britain actually had larger exports than the US