Geog1012 Week4 S1 2022

9/28/2022
Free Trade & Consequences
Instructor: dr. Frank van der Wouden
GEOG1012 – 1st semester 2022-2023
Links with previous lectures

• Week 2: Introduction
• Increase in economic development, trade & FDI
• Reduction in poverty, but great differences across regions exist
• Week 3: Capitalism & Globalization

• Modes of production have changed over time
• Capitalist mode of production has special characteristics that enable/give rise
to globalization
• Can someone give an example?
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Arguments I want to make today

• Trade is a fundamental feature of capitalism & globalization
• Proponents: Trade results in benefits for everyone

• Models: Absolute Advantage & Comparative Advantage
• Critics: Maybe the benefits are not equal to everyone…

• Model: Heckscher-Ohlin Model
Arguments I want to make today

• Trade is a fundamental feature of capitalism & globalization
• Proponents: Trade results in benefits for everyone

• Models: Absolute Advantage & Comparative Advantage
• Critics: Maybe the benefits are not equal to everyone…

• Model: Heckscher-Ohlin Model
• These models / ideas / logic find their way into politics
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1. FREE & INTERNATIONAL TRADE

• Introduction of the topic → why do we care in this class?
• Data: What is going on?
• Free Trade Theory
• Absolute Advantage (Smith)
• Comparative Advantage (Ricardo)
1. FREE & INTERNATIONAL TRADE

• Introduction of the topic → why do we care in this class?
• Data: What is going on?
• Free Trade Theory
• Absolute Advantage (Smith)
• Comparative Advantage (Ricardo)
2. IMPACT OF TRADE
• Extension of Trade Theory: → Heckscher-Ohlin Model
• “Terms of Trade” → inequalities in benefits?
• Costs & Benefits of Trade across Workers → example Los Angeles
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Why do we care?
Trade connects local production to:

•- global consumption
•- (spatial) division of labor
•- economic growth
•- and, possibly, inequalities
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TWO MAIN REASONS
1 - Ability:
Advancements in transportation
& communication technologies
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2 - Allow:
Reductions in barriers to trade
2 - Allow:
Reductions in barriers to trade
“Tariff reduction”
One of main goals

of the “GATT”
General Agreement
on Tariffs & Trade
Established at end
of WW2
Why?
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Why do countries trade?

• Countries don’t trade, but firms and consumers do
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• Smaller countries generally trade more, because they can only

produce a limited range of goods


• Larger countries generally trade less, because they usually have more
resources, larger markets and can produce a wider range of goods
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• Larger countries generally trade less, because they usually have more
resources, larger markets and can produce a wider range of goods
• If the division of labor is limited by the extent of the market, larger

countries are usually more efficient…
• But this is offset (to some extent) by globalization
Why? There are gains from trade!

• “Absolute Advantage”
• Adam Smith - 1776
• 2 Countries → 2 Goods with 1 input
• “Comparative Advantage”
• David Ricardo - 1817
• 2 Countries → 2 Goods with 1 input
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50
25
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25
50
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1. Before trade:
North: Absolutely more efficient producing bread
South: Absolutely more efficient producing milk
1. Before trade: 2. Start trade:

South: Absolutely more efficient producing milk Who needs to specialize producing what?
- North: Bread
- South: Milk
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1. Before trade: 2. Start trade:

South: Absolutely more efficient producing milk Who needs to specialize producing what?
- North: Bread
- South: Milk
3. Why?
Each country exploits absolute advantage and this will result in
gains from trade for both countries (next slides)
North: 2:1
South: 1:2
Together 3:3 == 1:1
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Pre-trade: production = consumption (you

can’t consume what you haven’t produced)
Pre-trade North:
Point A → producing & consuming 50
bread & 25 milk

Pre-trade North:
bread & 25 milk
Post-trade North:
Specializes & produces only bread – 100
units of bread
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Pre-trade North:
bread & 25 milk
Post-trade North:
units of bread
If the North consumes 60 bread it produced,
it can trade the remaining 40 units to the
South in return for 40 milk at the post-trade
exchange ratio of 1:1

Pre-trade North:
bread & 25 milk
Post-trade North:
units of bread
Point C: gains from trade North =
- 10 bread
- 15 milk
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Pre-trade North:
bread & 25 milk
Post-trade North:
units of bread
Point C: gains from trade North =
- 10 bread
- 15 milk

Pre-trade North:
bread & 25 milk
Post-trade North:
units of bread
E Point C: gains from trade North =
- 10 bread
- 15 milk
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Pre-trade South:
Point B → producing & consuming 25
bread & 50 milk

Pre-trade South:
bread & 50 milk
Post-trade South:
Specializes & produces only milk – 100
units of milk
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Pre-trade South:
bread & 50 milk
Post-trade South:
units of milk
If the South consumes 60 milk it produced, it
can trade the remaining 40 units to the
South in return for 40 bread at the post-
trade exchange ratio of 1:1
Point D: gains from trade South =
- 10 milk
- 15 bread

Gains from trade
= area between Pre-trade South:
PPC & CPC Point B → producing & consuming 25
bread & 50 milk
Post-trade South:
units of milk
If the South consumes 60 milk it produced, it
can trade the remaining 40 units to the
South in return for 40 bread at the post-
trade exchange ratio of 1:1
Point C: gains from trade South =
- 10 milk
- 15 bread
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Gains from Trade – Absolute Advantage

• Smith: “…each country is absolutely more efficient at producing one
commodity”
• Specialization → each country specializes in what they do best

generates gains for all trading partners
• More official: “Gains from trade are driven by differences in the

productivity at which each commodity is produced between the two
countries”
Comparative
Advantage
What if one country is more efficient
producing all commodities?
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Comparative
Advantage
What if one country is more efficient
producing all commodities?
Or, what if one country is not efficient at

producing anything…
David Ricardo
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90
90
45
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• North is absolutely more efficient than the South at producing both goods.
• Relative efficiency of the North in bread production is 100/90 and at milk production is 100/45
• North is absolutely more efficient than the South at producing both goods.
• Relative efficiency of the North in bread production is 100/90 and at milk production is 100/45
• North should specialize in milk production → relative (comparative) efficiency is greatest
• South should specialize in bread production → relative (comparative) in-efficiency is smallest
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North: 1:1
South: 2:1
Together 3:2 == 1.5:1
150
North: 1:1
South: 2:1
Together 3:2 == 1.5:1
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Post-trade:
North produces 100 liters of milk.
Assume they consumes 65 liters (point C) and sells

35 milk to the South in return for 52.5 bread.
Why 52.5? Because the post-trade exchange ratio is

1.5:1 or 1.5 bread for 1 milk
Gains from trade in the North = difference in levels

of consumption between A and C:
- 15 milk
- 2.5 bread
Post-trade:
South produces 90 breads.
Assume they consumes 37.5 breads (point D) and

sells 52.5 breads to the North in return for 35 milk.
Why 35? Because the post-trade exchange ratio is

Gains from trade in the South = difference in levels

of consumption between B and D:
- 5 milk
- 7.5 bread
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Post-trade:
South produces 90 breads.
Assume they consumes 37.5 breads (point D) and

sells 52.5 breads to the North in return for 35 milk.
Why 35? Because the post-trade exchange ratio is

Gains from trade in the South = difference in levels

of consumption between B and D:
- 5 milk
- 7.5 bread
North gains more than South... Inequalities?
Some conclusions
1. Gains from trade!
2. Gains for everyone!
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Some conclusions
3. But… how are gains from trade distributed between countries?

North gains more from trade than South...
Some conclusions
3. But… how are gains from trade distributed between countries?

North gains more from trade than South...
Next Problem:
How are gains from trade distributed across groups within countries?
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2. IMPACT OF TRADE
• Extension of Trade Theory: → Heckscher-Ohlin Model
• “Terms of Trade” → inequalities in benefits?
• Costs & Benefits of Trade across Workers → example Los Angeles
IMPACT OF TRADE
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Extension: Heckscher-Ohlin Model

• Objective:
• “Explain specialization for trade in a 2 good world, but with more than 1 input”
• Specialize in goods that use abundant input (= factors of production)

intensively
Extension: Heckscher-Ohlin Model

• Objective:
• “Explain specialization for trade in a 2 good world, but with more than 1 input”
• Specialize in goods that use abundant input (= factors of production)

intensively
• In general:
• Developed countries: well-endowed with capital & skilled labor → i.e. biotech
• Developing countries: large amounts of unskilled labor → i.e. clothing
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“Factor-price equalization”
• Key idea behind the H-O model
• Remember, factors of production are land, labor and capital
• “… prices of … factors of production (inputs) … will

become equalized across countries as a result of international trade.”
Assume:
Wheat = land intensive
Cloth = labor intensive
US:
• high labor wages
• land abundant
Rest of the world:

• low labor wages
• land scarce
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Assume:
US:
• land abundant
Rest of the world:

• low labor wages
• land scarce
Assume:
US:
• land abundant
Rest of the world:

• low labor wages
• land scarce
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Assume:
US:
• land abundant
Rest of the world:

• low labor wages
• land scarce
Assume:
US:
• land abundant
Rest of the world:

• low labor wages
• land scarce
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Assume:
US:
• land abundant
Rest of the world:

• low labor wages
• land scarce
Result: Product-Prize Equalization
Important:
THERE ARE WINNERS AND LOSERS
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“Specialize (and trade) in the good

that uses inputs that are in
abundance”
In the US, how do these exports (and

imports) affect:
- the wages of unskilled laborers?
- the wages of skilled laborers?
- land rents?
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Impact of trade – between countries

• Theoretical models suggest gains for all countries
• How these gains are distributed depend on the TERMS OF TRADE

• “Ratio of country’s export to import prices”
• Examples that affect TOT:

• Tariffs
• Subsidies
• Exchange Rates of Currencies
• These TOT impact the commodity prices set in international markets
Terms-of-Trade
• Refers to the price of a country’s exports relative to the price of its
imports
• Simple case:
• 2-commodity, 2 nation, 2 input:
• Terms of trade:
“the ratio of the price HK receives for producing & exporting clothing
relative to the price it has to pay for imported wheat”
• Do you see how this ratio can change through tariffs and subsidies?
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Impacts of Trade within Countries

• Wage inequality might increase as trade expands
• H-O arguments are the link → “abundant input”
• But unclear whether inequality is driven purely by trade or other

reasons
• Potential other factor: “Skill-biased Technological Change”
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Imports: Goods BOP
2,500,000
Imports (millions of dollars)

2,000,000
1,500,000
1,000,000
500,000
0
1960 1970 1980 1990 2000 2010
Year
Data: U.S. Census Bureau, Foreign Trade Division
“They took our jobs”

Off-shoring of low-skilled jobs & import those goods → increase wage inequality
Skill-biased technological change

• Technological change might make some workers more productive
than others.
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than others.
• Workers gaining productivity will receive higher wages → increase

wage inequality

than others.
• Workers gaining productivity will receive higher wages → increase

wage inequality
• Example:
• Differences in increased productivity from access to computer with Excel for
an accountant vs. farm worker
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A wage ratio of 100

means that wages
are equal between
the groups
compared.
A wage ratio of 100

means that wages
are equal between
the groups
compared.
What do we see in
terms of skills?
What do we see in
terms of changes
over time?
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Example of Los Angeles

• To what extent does SBTC or trade impact wages in Los
Angeles?
• 1990 and 2000
• Focus on:
• Spatial variation in export intensity
• Coefficients on ‘Import Competition’ across levels of education
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Table 6: Trade (import competition) and Wages by Education

Category, 1990
LN(AWS) LN(AWS) LN(AWS) LN(AWS)

EDUC = 1 EDUC = 2 EDUC = 3 EDUC = 4
AGE 0.017** 0.016** 0.017** 0.017**

(17.64) (16.54) (16.85) (15.37)
MALE 0.340** 0.344** 0.369** 0.329**
(15.68) (14.61) (17.89) (10.07)
WHITE 0.046* 0.092** 0.169** 0.144**
(2.18) (3.70) (7.16) (4.24)
NATIVE 0.256** 0.294** 0.214** 0.213**
(9.94) (9.30) (9.19) (5.19)
LN(SIZE) 0.037** 0.051** 0.033** 0.051**
(4.76) (6.96) (6.44) (6.63)
LN(K/L) 0.072** 0.046** 0.051** 0.080**
(8.46) (4.40) (4.85) (5.23)
LN(IMPORTCOMP) -0.030** 0.002 0.011 0.012
(3.93) (0.28) (1.79) (1.31)
CONSTANT 1.170** 1.479** 1.771** 1.931**
(21.65) (24.93) (33.11) (24.50)
# OBSERVATIONS 50260 34173 49785 39682

(weighted)
R2 0.16 0.21 0.20 0.17
Notes: Robust t-statistics in parentheses. * indicates significant at the 0.05 level.
** indicates significant at the 0.01 level. 1990 data.
Table 2: Trade (import competition) and Wages by Education

Category, 2000
LN(AWS) LN(AWS) LN(AWS) LN(AWS)

EDUC = 1 EDUC = 2 EDUC = 3 EDUC = 4
AGE 0.018** 0.018** 0.018** 0.011**

(13.94) (14.51) (15.42) (8.34)
MALE 0.356** 0.331** 0.306** 0.378**
(14.76) (11.90) (13.16) (11.18)
WHITE 0.086** 0.162** 0.143** 0.093**
(3.73) (5.67) (5.86) (2.71)
NATIVE 0.102** 0.127** 0.154** 0.277**
(2.46) (4.50) (5.77) (7.27)
LN(SIZE) 0.043** 0.042** 0.044** 0.038**
Impact of trade on
(3.79) (4.82) (6.49) (5.31)
LN(K/L) 0.055** 0.051** 0.027* 0.031** wage inequality is
(4.66) (3.46) (2.24) (2.61) real!
LN(IMPORTCOMP) -0.025** -0.017* -0.008 0.019
(3.53) (2.42) (1.18) (1.93) But, only for relatively
CONSTANT 1.437** 1.746** 2.060** 2.725**
(22.03) (22.87) (32.97) (28.62)
low-skilled people…
# OBSERVATIONS 38856 25780 34370 24857 For now…

(weighted)
R2 0.16 0.21 0.20 0.17
Notes: Robust t-statistics in parentheses. * indicates significant at the 0.05 level.
** indicates significant at the 0.01 level. 2000 data.
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What you should take-away

• There are gains from trade
• Even if a country is not efficient
• However, benefits from trade are not equal
• Different between countries (TOT!)
• Different within countries (skills!)
• We care because trade is increasing in the
age of globalization & impact lives
• How can we prepare ourselves? Skills!
45

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9/28/2022

Free Trade & Consequences

Instructor: dr. Frank van der Wouden

GEOG1012 – 1st semester 2022-2023

Links with previous lectures

• Week 3: Capitalism & Globalization

• Can someone give an example?

Arguments I want to make today

• Proponents: Trade results in benefits for everyone

• Critics: Maybe the benefits are not equal to everyone…

Arguments I want to make today

• Proponents: Trade results in benefits for everyone

• Critics: Maybe the benefits are not equal to everyone…

• These models / ideas / logic find their way into politics

1. FREE & INTERNATIONAL TRADE

1. FREE & INTERNATIONAL TRADE

Trade connects local production to:

TWO MAIN REASONS

One of main goals

Why do countries trade?

Why do countries trade?

Why do countries trade?

• Smaller countries generally trade more, because they can only

Why do countries trade?

• Smaller countries generally trade more, because they can only

Why do countries trade?

• Smaller countries generally trade more, because they can only

• If the division of labor is limited by the extent of the market, larger

Why? There are gains from trade!

1. Before trade: 2. Start trade:

1. Before trade: 2. Start trade:

Together 3:3 == 1:1

Pre-trade: production = consumption (you

Pre-trade: production = consumption (you

Pre-trade: production = consumption (you

Pre-trade: production = consumption (you

Pre-trade: production = consumption (you

Pre-trade: production = consumption (you

Pre-trade: production = consumption (you

Pre-trade: production = consumption (you

Pre-trade: production = consumption (you

Pre-trade: production = consumption (you

Gains from Trade – Absolute Advantage

• Specialization → each country specializes in what they do best

• More official: “Gains from trade are driven by differences in the

Or, what if one country is not efficient at

• North should specialize in milk production → relative (comparative) efficiency is greatest

• South should specialize in bread production → relative (comparative) in-efficiency is smallest

Together 3:2 == 1.5:1

Together 3:2 == 1.5:1

Assume they consumes 65 liters (point C) and sells

Why 52.5? Because the post-trade exchange ratio is

Gains from trade in the North = difference in levels

Assume they consumes 37.5 breads (point D) and

Why 35? Because the post-trade exchange ratio is

Gains from trade in the South = difference in levels

Assume they consumes 37.5 breads (point D) and

Why 35? Because the post-trade exchange ratio is

Gains from trade in the South = difference in levels

North gains more than South... Inequalities?

3. But… how are gains from trade distributed between countries?

3. But… how are gains from trade distributed between countries?

AGE 0.017 0.016 0.017 0.017

AGE 0.018 0.018 0.018 0.011