Trade Theory | Issues and Empirics

EC 380 - International Economic Issues

Jose Rojas-Fallas

2025

Recap

So far we have done a lot of work on learning trade theory

  • Comparative advantages determine trade flows

  • Differences in technology, factor endowments, location, and prosperity can all help countries decision to specialize

    • This can either be for final or intermediate goods

  • Recent technological advances have fragmented production processes across countries, furthering the importance of trade

Now we will focus on issues of trade with respect to jobs, wages, migration, and political economy

Employment

The China Shock - Abstract

The China Shock - Manufacturing Employment

The China Shock - Regression Results

The China Shock - Conclusion

To quote the authors concluding remarks:



Trade research has increasingly attempted to incorporate considerations for marginalized groups resulting from globalization

Trade & Employment

  • Trade with less developed countries has potentially led to spillover effects on local wage rates

  • Up until recently, decline in low-skill wage rates was only somewhat attributed to increased trade openness

  • It was initially suggested that tech improvements were driving the marginal productivity of skilled labor upward, driving up the wage gap

  • Since 2000, this gap has stagnated, leaving experts without a main explanatory factor anymore

Trade & Employment

Research in this area has seen a resurgence given that previously accepted reasoning on it has become outdated

A natural question that comes up is whether trade or technology plays a larger role in sector-specific outcomes

  • I think this question is too broad and not entirely helpful to counteract the issue

  • It may also redirect much needed attention from research that addresses how to facilitate reallocation among displaced manufacturing workers

Trade & Employment

Manufacturing firms that adopt specific technologies, such as computers or industrial automation, are significantly different from those that do not

  • They are larger and more productive upon adoption

While exposure to greater import competition is associated with employment decline, firms that increase their use of imported goods conditional on such exposure can exhibit employment gains

Should direct use of imported goods be considered a technological input?

Poverty and Inequality

If there are documented negative effects, how about positives?

Does International Trade Reduce Poverty & Income Inequality?

  • In 2013, China had 13.9% of the world’s skilled labor and 39.8% of the world’s less skilled labor
  • For the same year, China held 16% of world GDP
  • This makes them abundant in:
    • Low-skilled labor
  • And scarce in High-skilled labor
  • Trade openness translates to elevated demand for low-skill workers, and their wages rise

Poverty

“Towards the End of Porverty” from The Economist has the following to say:

  • The number of people living off of $1.25 per day was cut by one-half over the past 20 years
  • It has declined from 43% of the World Population in 1990 to 21% in 2010
  • Attributes much of this achievement to China

“China is responsible for three-quarters of the achievement… even though income equality is rising fast, extreme poverty is disappearing. China pulled 680m people out of misery in 1981-2010 and reduced its extreme poverty from 84% to 10%.”

Inequality

While global poverty has fallen due to free trade, what about income inequality?

  • Income inequality has been increasing
    • Higher incomes are rising more rapidly than lower incomes
  • The same is true of the US \(\Rightarrow\) The relative wages of skilled workers has been rising

This may seem counter-intuitive to what the HO model predicts

A model of offshoring better explains this phenomenon but is beyond this course

Migration

Labor Supply

So far our models have kept labor supplies fixed across countries and not allowed for migration of labor between countries

Workers were able to switch sectors in Ricardian, HO, and Specific Factors models but not country

If we were to incorporate this migration-feature into a model it may make it more realistic

Cause of Migration

There are many possible and imaginable reasons individuals may migrate. We can categorize them into:




Push Factors

Pull Factors

Social Networks

Migration: Push Factors

These are things that may incentivize individuals to move away from their origin country

  • Local purchasing power being too low
  • Housing too expensive
  • Recessions
  • Political strife/violence/uncertainty
  • War & famine


Climate change and related agricultural patterns may induce further mass-migrations in the coming future

Migration: Pull Factors

These are things that may draw people into a receiving country



  • Income levels
  • Healthcare
  • Socioeconomic stability
  • Educational support/institutions

Migration: Social Networks

Not Facebook. But rather “personal reasons” that may draw individuals and make them congregate in certain places:



  • Family ties
  • Local affinities to surroundings
  • Ethnic groupings/enclaves
  • Insider opportunities

Migration - Theory

In theory, suppose we were in a scenario where trade was already open and now we wanted to allow for the free movement of labor

In theory, free movement of labor will see wages harmonize across countries as we saw them across industries in our simple models

It will do that to an extent, but the gap between countries will still exist somewhat

The European Union is a great real-world example of this process:

  • Brexit placed a great deal of focus on limiting the movement of people while trying to ekep the movement of goods open

Migration - Practice

In practice, empirics have shown evidence of effects of low-skilled worker inflows not impacting other local worker groups

Migration - Practice

Our very own Mark Colas recently published:

Migration - Practice

In practice, high-skilled migrant influxes show a similar lack of impact

Migration: Effects on Wages

We will keep it simple by assuming there are:

  • Two countries
  • Produce a single good made with labor and an immobile factor

Since there is only one good, there is no reason to trade however there will be “trade” in labor services

  • Workers move in search of higher wages

In the absence of migration, wage differences across countries can be through technology differences, or differences in the availability of the immobile factor

Migration: Effects on Wages

Migration: Effects on Wages

Home workers: \(OL^{1}\)

Foreign workers: \(L^{1}O^{*}\)

Immobile Factor endowments are different and cause real wages to be higher in Foreign (point B) than in Home (Point C)

Who moves where?

Home workers will migrate to Foreign

This reduces the Home labor force and raises the real wage in Home

In Foreign the opposite occurs

Migration: Short-Run

Let’s view a stylized example of how migration may impact local labor markets in the Short-Run

Recall the OH model, where labor can move between industries but capital is fixed

We also have that labor is a sum of both industry labor, such that:

\[\bar{L} = L_{x} + L_{y}\]

Migration: Short-Run

Migration: Short-Run

Migration: Short-Run

Effects

  • Immigration causes total labor to change: \(\bar{L}' = \bar{L} + \Delta L\)
  • Shifting out the supply curve of industry \(x\) causes the corresponding marginal productivity curve to shift right by \(\Delta L\)

Migration: Short-Run

Equilibrium Outcomes

  • Number of workers in both industries rises
  • Wages across both industries fall
  • Why?
    • Labor became less scare/more abundant, relative to the fixed amount of capital/land

Migration: Long-Run

In the Long-Run other things are allowed to move which makes outcomes somewhat different:

  • Given a rise in labor (\(\bar{L}\) to \(\bar{L}'\) in our example), capital/land/labor ratios readjust
    • Immobile factors are free to shift in the Long-Run
  • Instead of what we see in the Short-Run, these ratios adjust to ideal levels such that ideal production levels are maintained
  • \(\Delta L\) will flow entirely into the labor-intensive industry

Political Economy

Political Economy of Trade

There are many points of view of how international trade should be treated through a political view

Up until now we have seen there are both good and bad outcomes of trade, happening at the exact same time

Take for example the following scenario:

  • In the US, workers in the import-competing sectors earn wages substantially below the average wage, and those workers earning the lowest wage face the highest risk of separation from their current employer due to import competition

Political Economy: Possible Outcomes

We have workers in import-competing sectors earning lower wages than average and facing a higher risk of unemployment

Let’s take the example of production workers in the apparel sector in 2019 where wages were below 25% the average wage for all production workers

We could have:

  • There may be widespread sympathy for the situation these workers are going through and, consequently, restrictions on apparel imports
  • If this happens, gains from more affluent consumers that would have happened with more imports do not realize.

Political Economy: Trade is Good?

Most economist sure think so

There are three main reasons why economists do not generally stress the income distribution effect of trade:

  • Income distribution effects are not specific to international trade

  • It is always better to allow trade and compensate those who are hurt by it than to prohibit the trade

  • Those who stand to lose from increased trade are typically better organized than those who stand to gain.

This rings somewhat true if we are considering industries.

But people are not industries, and when in a democracy, people have the ability to influence their political context

Electoral Competition

Let me introduce some political science concepts to motivate possible political shifts due to trade

Suppose the following:

  • There are two competing parties that are willing to promise whatever will enable each to win the next election
  • Policy can be described along one dimension
    • Something simple like a tariff rate level
  • Voters differ in the policies they prefer

Electoral Competition - Example

Let’s think of a simple example:

Imagine a country that exports high skill-intensive goods and imports low- skill-intensive goods. Political parties are divided alongside the level of tariff rate to impose

There are two type of voters:

High-skill voters

  • Prefer low tariff rates

Low-skill voters

  • Prefer high tariff rates

Think what the Stolper-Samuelson Theorem says to explain this

What Policy to Choose?

If we think about lining up all the voters in the order of the tariff rate they prefer, with the voters who favor the lowest rate on the left and those who favor the highest rate on the right we get:

Median Voter

Parties will converge on the tariff rate preferred by the median voter

To see why, think what happens if one party takes the position of tariff \(t_{A}\)

The other party could propose a slightly lower rate \(t_{B}\), which is preferred by almost all other voters.

It is always in their interest to undercut any tariff proposal that is higher than what the median voter wants

Median Voter and Trade

Interestingly enough, the median voter model does not seem to work well for trade policy

According to this model, a policy should be chosen based on how many voters it pleases:

  • A policy that inflicts large losses on a few people but benefits a large number of people should be a political winner

  • A policy that inflicts widespread losses but helps a small group should be a loser

However, this is not usually the case:

  • Usually, voters consider protectionist trade policy which will benefit only a few while harming a majority

    • Think of the US diary industry which is protected through an elaborate system of tariffs and quotas
    • These restrictions make dairy products slightly more expensive for consumers while benefiting an industry which employs about 0.1% of the workforce

Importing Political Polarization?

Autor et al - Importing Political Polarization (2020)

Autor et al - Importing Political Polarization (2020)

Autor et al - Importing Political Polarization (2020)

Autor et al - Importing Political Polarization (2020)

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