Description
It explains the theory, interpretations, liberalization, autarky model, NAFTA, leontief paradox
FACTOR PRICE EQUALIZATION
GLOBAL EXPERIENCE POST LIBERALIZATION
Subject - Globalization and Indian Economy
Factor Price Equalization Theorem
Given certain conditions and assumptions, free trade equalizes not only product prices but also
the prices of individual factors between the two
countries. Trade in goods and services is basically
Interpretation of FPE
?
Even if factors cannot migrate between countries directly,
? Laborers
of the same skill level earn the same in
both the countries
? Units
of land of comparable quality earn the same
rental return in both the countries
Assumptions of FPE Theorem
1.
2.
3. 4. 5. 6. 7. 8. 9.
2-2-2 model Complete factor mobility and fully employed Perfectly competitive markets Technology involves constant returns to scale Incomplete specialization in production No government restrictions No transport costs Same technology used in both countries No factor intensity reversals
FPE and the real world
?
In the real world,
in India and US don’t earn the same ? Governments do impose trade barriers ? Technologies across nations do differ
? Laborers
?
Does this mean FPE Theory is a failure? NO
? Opening
up trade creates a tendency towards
FPE ? Real wage rates in countries like Singapore and South Korea are fast approaching wages rates in the western industrialized countries
What is liberalization?
?
The process of opening up imports and exports and doing away with tariffs, quantitative restrictions, import licenses etc
?
Examples
? India’s
liberalization program starting 1991 ? China in the early 1980’s ? Latin American countries during 1980s-1990s
INDIA’s software industry
India’s development strategy pre 1991
? ? ? ? ?
Inward looking and highly interventionist Import protection – high nominal tariffs Complex industrial licensing norms Pervasive government intervention Public ownership of heavy industry
Trade Policy changes since 1991
? ? ? ?
Easing of industrial licensing Public enterprise reforms Reduced tariffs for imports Easier trade
Comparison of labor and capital endowments of India and the US
?
US is relatively capital abundant
unskilled labor ? higher wages ? Relatively cheaper capital
? Expensive
?
India is relatively labor abundant
unskilled labor ? lower wages ? Relatively expensive capital
? Cheap
No Trade Situation - Autarky
2 Country A - India
CIC
2 - Capital Intensive Item PB
Country B - US
(P1 / P2) B
Q2 B
PA Q2 A (P1 / P2) A
Q1B PB’
Q1 A
PA’
1
1- Labor Intensive Item
Explanation
?
?
?
? ?
Since the terms of trade of both countries differ there exists an arbitrage possibility Arbitrage leads to trade between both countries India exports cheap labor services US imports cheap labor services In the long run as per the FPE theory the terms of trade of both US and India will equal the world terms of trade (P1 / P2)W
Benefits from outsourcing
?
Benefits to US
? Cheaper
software costs ? Large labor force available
?
Benefits to India
? Employment
for labor force ? Better wages for the labor force
Points to ponder upon…
?
?
?
?
?
As wages in India increase, exports will become less competitive compared to before Operating margins will fall due to increased wages This will lead to sluggish growth of outsourcing business Others like Eastern European and Latin American countries will capitalize on India’s loss of outsourcing business Indian outsourcing can survive only if it increases its productivity level
Tracing the impact of Trade Liberalization on Wage Inequality in Mexico
Background
?
?
? ?
?
Mexican government exercised export control for 4 decades Most barriers were in the form of import tariffs and import licenses In 1985 Mexico joined GATT Most trade barriers were drastically reduced in the following 3 years By 1987, import and export restrictions were removed, exchange rate was devalued and barriers to foreign investment were removed
The Problem
?
Since 1985 wages of ‘more educated - more experienced’ rose relative to ‘less educated less experienced’
Why did this happen?
?
?
Reduction in tariff protection disproportionately affected the low skilled industries Increased competition from economies with large reserves of cheap unskilled labor – like China
The Problem - explained
Abolished tariff restrictions Price of skill intensive goods rise relative to non skill intensive goods Demand for labor in skill intensive industries grows Demand for skilled labor grows Wages of skilled labor increases compared to unskilled labor
In a nutshell
?
?
?
?
Mexico before 1985 protected its non-skill intensive sectors preferentially Import tariff protection to unskilled labor intensive sector may have been due to political compulsions Once liberalization happened, the non-skill intensive sector found itself uncompetitive as compared to larger economies like China Laborers in the skill intensive sectors gained as a result of opening up of Mexico’s trade
In a nutshell…contd
?
?
?
?
Mexico’s unskilled labor was now worse off than before – reduced wages The skilled labor was better off than before – increased wages This change in factor prices was a result of Mexico’s protectionist environment and not a result of its factor endowments The relative wage change occurred without large changes in relative employment
NAFTA
?
?
? ?
North American Free Trade Agreement Canada, the USA and Mexico Tariff elimination on certain goods 70 percent of Mexican exports to the U.S. were tariff free and as were 50 percent of U.S. exports to Mexico.
NAFTA – Factor endowments
?
The USA
? Capital
intensive economy ? Capital for agriculture cheap ? High wage rate
?
Mexico
? Labour
intensive ? Capital for agriculture expensive ? Low wage rate
NAFTA – Resistance
?
The USA
? Opposition
from labour unions
?
Mexico
? Opposition
from Mexican farmers
The result - Mexico
?
Farmer suicides in Mexico
?
Wage rates increased, but marginally
The result - The USA
?
U.S. agricultural exports to Mexico were about 3 percent higher in 1996 than they would have been without the reduction in trade barriers under NAFTA. Estimate of job loss by Robert E. Scott:
? 879280
?
jobs lost between 1994 and 2002
Can factor prices ever become equal between two countries?
?
?
Real world data shows that factor prices never become equal There is a tendency to become equal
References
?
The Indian Business Process Outsourcing Industry: An Evaluation of Firm-Level Performance - Arti Grover Trade liberalization and wage inequality in Mexico – Gordon H Hanson and Ann Harrison
?
Thank you
doc_494555152.pptx
It explains the theory, interpretations, liberalization, autarky model, NAFTA, leontief paradox
FACTOR PRICE EQUALIZATION
GLOBAL EXPERIENCE POST LIBERALIZATION
Subject - Globalization and Indian Economy
Factor Price Equalization Theorem
Given certain conditions and assumptions, free trade equalizes not only product prices but also
the prices of individual factors between the two
countries. Trade in goods and services is basically
Interpretation of FPE
?
Even if factors cannot migrate between countries directly,
? Laborers
of the same skill level earn the same in
both the countries
? Units
of land of comparable quality earn the same
rental return in both the countries
Assumptions of FPE Theorem
1.
2.
3. 4. 5. 6. 7. 8. 9.
2-2-2 model Complete factor mobility and fully employed Perfectly competitive markets Technology involves constant returns to scale Incomplete specialization in production No government restrictions No transport costs Same technology used in both countries No factor intensity reversals
FPE and the real world
?
In the real world,
in India and US don’t earn the same ? Governments do impose trade barriers ? Technologies across nations do differ
? Laborers
?
Does this mean FPE Theory is a failure? NO
? Opening
up trade creates a tendency towards
FPE ? Real wage rates in countries like Singapore and South Korea are fast approaching wages rates in the western industrialized countries
What is liberalization?
?
The process of opening up imports and exports and doing away with tariffs, quantitative restrictions, import licenses etc
?
Examples
? India’s
liberalization program starting 1991 ? China in the early 1980’s ? Latin American countries during 1980s-1990s
INDIA’s software industry
India’s development strategy pre 1991
? ? ? ? ?
Inward looking and highly interventionist Import protection – high nominal tariffs Complex industrial licensing norms Pervasive government intervention Public ownership of heavy industry
Trade Policy changes since 1991
? ? ? ?
Easing of industrial licensing Public enterprise reforms Reduced tariffs for imports Easier trade
Comparison of labor and capital endowments of India and the US
?
US is relatively capital abundant
unskilled labor ? higher wages ? Relatively cheaper capital
? Expensive
?
India is relatively labor abundant
unskilled labor ? lower wages ? Relatively expensive capital
? Cheap
No Trade Situation - Autarky
2 Country A - India
CIC
2 - Capital Intensive Item PB
Country B - US
(P1 / P2) B
Q2 B
PA Q2 A (P1 / P2) A
Q1B PB’
Q1 A
PA’
1
1- Labor Intensive Item
Explanation
?
?
?
? ?
Since the terms of trade of both countries differ there exists an arbitrage possibility Arbitrage leads to trade between both countries India exports cheap labor services US imports cheap labor services In the long run as per the FPE theory the terms of trade of both US and India will equal the world terms of trade (P1 / P2)W
Benefits from outsourcing
?
Benefits to US
? Cheaper
software costs ? Large labor force available
?
Benefits to India
? Employment
for labor force ? Better wages for the labor force
Points to ponder upon…
?
?
?
?
?
As wages in India increase, exports will become less competitive compared to before Operating margins will fall due to increased wages This will lead to sluggish growth of outsourcing business Others like Eastern European and Latin American countries will capitalize on India’s loss of outsourcing business Indian outsourcing can survive only if it increases its productivity level
Tracing the impact of Trade Liberalization on Wage Inequality in Mexico
Background
?
?
? ?
?
Mexican government exercised export control for 4 decades Most barriers were in the form of import tariffs and import licenses In 1985 Mexico joined GATT Most trade barriers were drastically reduced in the following 3 years By 1987, import and export restrictions were removed, exchange rate was devalued and barriers to foreign investment were removed
The Problem
?
Since 1985 wages of ‘more educated - more experienced’ rose relative to ‘less educated less experienced’
Why did this happen?
?
?
Reduction in tariff protection disproportionately affected the low skilled industries Increased competition from economies with large reserves of cheap unskilled labor – like China
The Problem - explained
Abolished tariff restrictions Price of skill intensive goods rise relative to non skill intensive goods Demand for labor in skill intensive industries grows Demand for skilled labor grows Wages of skilled labor increases compared to unskilled labor
In a nutshell
?
?
?
?
Mexico before 1985 protected its non-skill intensive sectors preferentially Import tariff protection to unskilled labor intensive sector may have been due to political compulsions Once liberalization happened, the non-skill intensive sector found itself uncompetitive as compared to larger economies like China Laborers in the skill intensive sectors gained as a result of opening up of Mexico’s trade
In a nutshell…contd
?
?
?
?
Mexico’s unskilled labor was now worse off than before – reduced wages The skilled labor was better off than before – increased wages This change in factor prices was a result of Mexico’s protectionist environment and not a result of its factor endowments The relative wage change occurred without large changes in relative employment
NAFTA
?
?
? ?
North American Free Trade Agreement Canada, the USA and Mexico Tariff elimination on certain goods 70 percent of Mexican exports to the U.S. were tariff free and as were 50 percent of U.S. exports to Mexico.
NAFTA – Factor endowments
?
The USA
? Capital
intensive economy ? Capital for agriculture cheap ? High wage rate
?
Mexico
? Labour
intensive ? Capital for agriculture expensive ? Low wage rate
NAFTA – Resistance
?
The USA
? Opposition
from labour unions
?
Mexico
? Opposition
from Mexican farmers
The result - Mexico
?
Farmer suicides in Mexico
?
Wage rates increased, but marginally
The result - The USA
?
U.S. agricultural exports to Mexico were about 3 percent higher in 1996 than they would have been without the reduction in trade barriers under NAFTA. Estimate of job loss by Robert E. Scott:
? 879280
?
jobs lost between 1994 and 2002
Can factor prices ever become equal between two countries?
?
?
Real world data shows that factor prices never become equal There is a tendency to become equal
References
?
The Indian Business Process Outsourcing Industry: An Evaluation of Firm-Level Performance - Arti Grover Trade liberalization and wage inequality in Mexico – Gordon H Hanson and Ann Harrison
?
Thank you
doc_494555152.pptx