2. Objectives
1. Explain why trade will generate both winners and losers in the short
run.
2. Describe the reasons why trade is a politically contentious issue.
3. Predict how immigrations may affect an economy.
3. Income Distributional Effect of Trade
• On the Ricardian model of trade, labor is only factor of production, so
not only that all countries gain from trade, but also that every
individuals is made better off as a result of international trade.
• If trade is so good for the economy, why is there such opposition?
• In reality, trade creates winners and losers in an economy – Income
distribution effect of trade.
4. Reasons for income Distributional Effect
• Two main reasons why international trade has strong effects on the
distribution of income within a country:
• Short-run effect: Resources cannot move immediately or costlessly
from one industry to another. (Learning Unit 7).
• Long-run effect: Industries differ in the factors of production they
demand. (Learning Unit 9).
5. Relative Price and Distribution of Income
• When a country engages in trade, a relative price of goods will
change.
• When a relative price changes, how will it affect the incomes of the
following three groups?
– Workers (mobile factor)
– Owners of capital (immobile factor) in cloth sector
– Owners of land (immobile factor) in food sector
• Suppose that PC increases by 10%. Then, the wage would rise by less
than 10%.
6. • An area under marginal revenue product
curve is total revenue.
• When additional dLC hours of labor is
hired, it brings MRPC of revenue per hour.
• Additional dLC hours of labor will bring
MRPC x dLC of revenue (shaded area under
MRPC curve) in total.
Marginal revenue
product, MRPC
MRPC
Marginal Revenue Product Curve and Total
Revenue
7. Measuring Distribution of Income
• Under an assumption of zero economic profits, total
revenue must be paid to owners of factors used for
production –labor and capital owners in cloth sector.
• A rectangular area below the wage rate (w) is total
wage payment to labor (wage rate x labor hours).
– w1 x LC
1 = total wage payment to labor
• Total revenue (TR) is an area below MRP curve.
• A triangle area below MRP but above the wage rate is
total payment to capital owners.
– TR = Payment to Labor + Payment to Capital Owners
MRPC
Marginal revenue
product, MRPC
w1
8. Real Wage Rate and Real Income
• Real wage rate: Nominal wage rate divided by price of output (w/P)
– A proportional increase in prices and wage will keep a real wage rate
constant.
• Real Income: Nominal income divided by price of output
– Real income measures how many goods a person can purchase with his/her
nominal income.
– Alternative, it can be computed as
Real income = real wage rate x labor hours
– A proportional increase in prices and wage (nominal income) will keep real
income constant.
– Factor owners will benefit when their real income increases, not nominal
income.
9. Measuring Distribution of Real Income
• Dividing the labor demand curve by output price
gives
MRPC /PC = MPLC x PC / PC = W/PC
MPLC = W/PC
• The vertical axis measures real wage rate.
• An area below MPL curve measure total output.
• A rectangular area below the wage rate (w) is total
real wage payment to labor.
• A triangle area below MPL but above the real wage
rate is total real payment to capital owners.
10. Effect of Rise in Price on Owners of Capital
When relative price of cloth (PC/PF) increases
• the output of cloth (QC) rises, so as the labor
input in cloth sector (LC).
• The real wage rate (w/PC) decreases.
• Real income of capital (immobile factor)
owners increases, while real income of labor
may increase or decrease.
11. Effect of Rise in Price on Landowners
When relative price of cloth (PC/PF) increases,
relative price of food (PF/PC) decreases, and
• the output of food (QF) falls, so as the labor
input in food sector (LF).
• The real wage rate (w/PF) increases.
• Real income of land (immobile factor)
owners decreases, while real income of labor
may increase or decrease.
12. Change in Relative Price and Distribution of
Real Income
When a relative price of good increases, a relative price of the other
goo decrease.
• Owners of immobile factors in production of the good whose relative
price increase are definitely better off.
• Owners of immobile factors in production of the other good whose
relative price decreases are definitely worse off.
• Mobile factor owners (labor) may or may not be better or worse off:
– Depends on the relative importance of cloth and food in workers’
consumption.
13. Definitely Better Consumption Area
• Under autarky a country produces and consumes
cloth and food at Point 2 on PPF
– A shaded rectangular area indicates a
consumption combination which is definitely
better than Point 2 because the country can
consume more of one or both goods than
Point 2.
14. Budget Constraint and Gains from Trade
• Under trade the county produces QC
1 of cloth and
QF
1 of food at Point 1 on PPF and is able to sell
and buy goods at a relative price of PC/PF.
– The country can choose any point along the
budget constraint line by trading goods at PC/PF.
– The budget constraint line is equivalent to the
trade possibility line (TF line) on Ricardian
model.
– Choosing a point on the budget constraint line
under shared rectangular area, it is possible for
the country to consume more of both goods
than it would have in the absence of trade.
15. Gains from Trade and Distribution of Income
• The economy as a whole gains from trade.
– It is able to afford amounts of cloth and food that the country is not able to
produce itself because the budget constraint with trade lies above the
production possibilities frontier.
• There are winners and losers from trade
– Because trade is beneficial only if a country can trade at a relative price
different from the domestic relative price under autarky, this change in
relative price causes distributional effects on incomes among factor owners.
– Trade benefits the factor that is specific to the export sector of each country
but hurts the factor that is specific to the import-competing sectors.
16. Politics of Trade and Income Distribution
• Trade often produces losers as well as winners.
– Optimal trade policy must weigh one group’s gain against another’s loss.
• Because the country as a whole benefits from trade, it is possible to redistribute
income so that everyone gains from trade.
– Those who gain from trade could compensate those who lose and still be
better off themselves. However, in practice, it is hard to implement
redistribution.
• Typically, those who gain from trade are a much less concentrated, informed, and
organized group than those who lose.
– Special interest groups who suffer from trade always have louder voice against
trade in politics.
17. Trade and Unemployment
• Trade shifts jobs from import-competing to export sector.
– Process not instantaneous – some workers will be unemployed as they look for
new jobs.
– New jobs may require new skills, which are difficult for older unemployed
workers to acquire.
• How much unemployment can be traced back to trade?
– From 2001 to 2010, only about 2% of involuntary displacements stemmed from
import competition or plants moved overseas.
18. Unemployment and Import in the U.S.
• There no evidence of a positive
correlation between
unemployment and imports
(relative to U.S. GDP) for the U.S.
• Unemployment is primarily a
macroeconomic problem that
rises during recessions –
Frictional unemployment.
Note: The highlighted years are recession years
19. U.S. Manufacturing Employment and Import
from China
• Some argue that the import competition from
developing countries, especially from China, is at fault
for declines in manufacturing jobs in the U.S.
– They advocate closing off the U.S. from trade with China to
save manufacturing jobs in the U.S.
• Facts are
– The manufacturing employment share has been steadily
decreasing over the last half-century well before imports
from China began to increase in 1990s.
– But, U.S. manufacturing was still producing the same
quantity of goods, but was using fewer and fewer workers
(due to increase productivity).
– Main source of manufacturing job loss in the U.S. is
technological advancement; Machines replace workers’ jobs
20. Trade Adjustment Assistance Program
• Labor with limited skill in import-competing sectors are immobile in sense that
they cannot easily transfer their skills to other sectors and are often required to
move geographically to get other jobs.
• Governments usually provide a “safety net” of income support to cushion the
losses to groups hurt by trade (or other changes).
• U.S. Trade Adjustment Assistance program provides
– Extended unemployment coverage to workers who are displaced by a plant
closure due to import competition
– Retraining programs often free from local community colleges.
21. International Factor Mobility
• Movements in factors of production across boarders include
– labor migration
– the transfer of financial assets through international borrowing and lending
– transactions of multinational corporations involving direct ownership of
foreign firms
• Like movements of goods and services (trade), movements of factors
of production are politically sensitive and are often restricted.
22. International Labor Mobility – Model Setup
• Why does labor migrate and what effects does labor migration cause?
• Modify Specific Factors Model with following setups:
– Workers migrate to wherever wages are highest (like movement from one sector to
another).
– Consider movement of labor across countries instead of across sectors (instead of two
sectors in one country, one sector in two countries).
– Two countries produce one non-traded good (food) using two factors of production:
Land cannot move across countries (immobile factor)
Labor can move across countries (mobile factor).
– No trade of goods
The model depicts labor mobility as substitute for flow of goods across countries.
23. International Labor Mobility - Diagram
• Instead of two sectors, the labor demand in two
countries (Home and Foreign)
– MPL in Home and MPL* in Foreign
• Total labor supply in two countries is measure along
the horizontal axis.
– A quantity of labor in Home is measured from O, and a
quantity of labor in Foreign is measured from O*.
• Before immigration at L1, large supply of labor in
Home relative to Foreign leads to lower wage rate in
Home than Foreign.
– Labor supply is OL1 in Home and O*L1 in Foreign.
– Real wage rate is wC in Home and wB in Foreign.
wB
wC
24. Effects of International Labor Mobility
• Labor moves from Home to Foreign (L1 to L2) to seek for
higher wage.
– A number of immigrants from Foreign to Home is L1L2.
• Wage rate increases in Home (from wC to wA) and
decreases in Foreign (from wB to wA).
– As labor supply decreases, MPL increases in Home.
– As labor supply increases, MPL decreases in Foreign.
– Eventually, wage rate equalizes across countries (at wA).
• World production of goods increase by the area shaded
(area below MPL is Total Product).
– This gain from immigration is similar to gains from trade.
wB
wC
wA
25. Distributional Effects of International Labor
Mobility
• Immigration of labor has distributional effects on factor owners.
– Workers initially in Home benefit by earning higher real wages.
– Workers in Foreign are hurt by decreasing real wages.
– Owners of immobile factors (land and capital) in Foreign gain from the
immigration of labor, which decreases real wages and increases output in Foreign.
– Owners of immobile factors (land and capital) in Home are hurt by the
immigration of labor, which increases real wages and decreases output in Home.
• The U.S. faces inflows of immigrants from the south of boarder.
– How will it affect labor, capital, and land owners in the U.S.? Who oppose the
immigration?
26. Effects of Migration of Labor - Evidence
• Up until the eve of
World War I in 1913,
wages rose faster in
origin countries than in
destination countries
(except Canada).
• Migration moved the
world toward more
equalized wages.
27. Effects of Migration of Labor - Evidence
• Due to higher wages in Western Europe relative to
its new EU partners in Eastern Europe, there have
been substantial east-to-west migration flows.
• A relative wage of manufacturing workers from the
new 2004 member countries relative to Western
Europe has been increasing as a result of migration
of labor.
– Before joining EU, Eastern European workers earned
about 15% of Western European workers.
– After joining EU, Eastern European workers earned
about 25% of Western European workers.
– Wage convergence between Eastern and Western
European workers.
28. Immigration in the U.S.
• In the early 20th century, share of
immigrants in the U.S. increased
dramatically.
• Restrictions on immigration in the
1920s led to a sharp decline in the
foreign-born population in the mid-
20th century.
• New wave of immigration began
around 1970.
• As of 2014, 16.7% of the U.S. labor
force is foreign-born.
29. Pattern of Immigration in the U.S.
• Relative to native-born workers, foreign-born
workers are concentrated in both the highest and
lowest educational groups.
• The largest increase in recent immigration
occurred among workers with the lowest
education levels, making less educated workers
more abundant.
– possibly reduced wages for native-born workers
with low education levels while raising wages for
the more educated
– widening wage gap between less educated
workers and highly educated workers.
30. Capital Mobility
• Labor is not the only factor to move across boarders. Due to tighter restrictions on
immigration, instead of labor immigrating to the U.S., capital is emigrating to
developing countries where real wage rates are low (capital owners will earn more).
• If capital is a mobile factor and labor is immobile factor, then how a movement of
capital from the U.S. to foreign countries affects factor owners in the U.S.?
– Owners of immobile factors (labor) in the U.S. are hurt by the outflow of capital
which decrease real wages.
• Foreign direct investment (FDI): a direct investment into production or business in a
country by an individual or company of another country.
– Off-shoring is a form of capital outflows from the U.S. to other countries.
31. Disclaimer
Please do not copy, modify, or distribute
this presentation
without author’s consent.
This presentation was created and owned
by
Dr. Ryoichi Sakano
North Carolina A&T State University
Disclaimer
Please do not copy, modify, or distribute
this presentation
without author’s consent.
This presentation was created and owned
by
Dr. Ryoichi Sakano
North Carolina A&T State University
