International trade increases a nation's overall income, but some can be hurt

August 24, 2017

Jack_Rivolta,_First_foreign_trade_zone,_WPA_poster,_1937

 

By far, the majority of economists favor policies that foster increased international trade. Economic theory and real world evidence point to increased trade as a positive force in raising incomes in the United States and the world. In my my first blog post on trade (see related posts by searching by the tag international trade)  I went over the most basic reasoning behind this support, comparative advantage. International trade allows a country or region to specialize in products in which it has a comparative or relative advantage, and to trade those for products other countries can produce relatively more efficiently. In that way, real income increases for countries on both sides of the trade.

 

The economist David Ricardo put forth the proposition of comparative advantage 200 years ago in his book, Principles of Political Economy and Taxation. He used as examples, Portugal's comparative advantage in producing wine and England's advantage in producing cloth. To this day many economic textbooks explain comparative advantage still using the England and Portugal and cloth and wine illustration.

 

Ricardo published his exposition on comparative advantage in 1817. In 1919, a Swedish economist, Eli Filip Heckscher published an article that began to put a firmer understanding of a basic underlying cause of differences in country comparative advantage, namely that countries differ in the size of their labor force relative to how much productive and fertile land they have and how much mineral and energy resources they have relative to labor and how much educated and skilled labor they have relative to less skilled labor, even how much infrastructure they have in terms of ports and railroads relative to agricultural land . It is not how much of these factors that countries have, but rather the relative size, i.e., the ratio of labor to land, or the ratio of skilled labor to unskilled labor. Heckscher argued that it is these differences among countries that determine in large measure differences among countries in comparative advantage.

 

In 1933, Bertil Ohlin, another Swedish economist and a student of Hecksher, extended and elaborated on Hecksher's work, publishing Interregional and International Trade, in which he put forth the theory that countries will export those product which most use those inputs to produce - land, skilled labor, unskilled labor, energy sources, minerals - which it has most in abundance, and will import products which use inputs which it has in least abundance. This theory became known as the Hecksher-Ohlin theorem. Ohlin got a Nobel prize in Economics in 1977.

 

Now, as noted in my blog post, Economists do it with models International Trade Debate II, economists work with models to simplify the real world in order to come up with some conclusions, conclusions that because of real world complexity may never reveal themselves. Well here is a story of how Ricardo used a simple model that provided an answer about how trade between two countries can raise the living standards in both countries. But while Ricardo's model could answer the question about how and why two countries that engage in trade can each be better off as a result of the trading, it couldn't be used to answer other important questions. For example, what happens to wages paid to labor as a result of trade. To answer that question, a model would have to explicitly have inputs such as labor included in the model.

Well the Hecksher-Ohlin model of international trade does have labor inputs embedded in it.

 

In 1940, two American economists, Wolfgang Stolper and Paul Samuelson used a version of the Hecksher-Ohlin model to ask that question, what happens to the wages of workers who work in an industry that uses a lot of labor and that suddenly faces competition from imports from countries who can produce the goods more cheaply. Well the price of the goods that the industry produces will have to fall to meet the import competition. Since that price must cover all the cost of production, including all the payments to labor and other inputs that the industry uses (or it will lose money and go out of business entirely), at least one of the prices paid to inputs that the industry uses will have to fall. The most likely input that will suffer the most will be labor, hence wages paid to labor in that industry can very well take a hit.

 

The Stolper-Samuelson theorem was the first instance of a tightly reasoned argument which offered a theoretical conclusion that there could be losers as a result of international trade. Now the conclusion doesn't obviate previous conclusions that international trade raises the overall income of a country, just that there may be some who lose out. And the gains from trade on overall income are likely to be much larger than the possible losses to labor in the import impacted industries. But that doesn't make it any easier on those who lose.

 

 

References:

 

On Hecksher-Ohlin

https://www.britannica.com/biography/Eli-Filip-Heckscher#ref262148

https://www.britannica.com/biography/Bertil-Ohlin#ref205880

On Stolper-Samuelson

https://www.economist.com/news/economics-brief/21703350-third-our-series-looks-stolper-samuelson-theorem-inconvenient-iota

http://rodrik.typepad.com/dani_rodriks_weblog/2008/06/stolper-samuelson-for-the-real-world.html

 

 

 

 

 

 

  

 

 

  

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