International Trade Theory and Policy; 2nd ed

Springer Texts in Business and Economics

International

Trade Theory

and Policy

Giancarlo Gandolfo

With contributions by Federico Trionfetti

Second Edition

Springer Texts in Business and Economics

For further volumes:

http://www.springer.com/series/10099

Giancarlo Gandolfo

International Trade Theory

and Policy

Second edition

With contributions by Federico Trionfetti

123

Giancarlo Gandolfo

Accademia Nazionale dei Lincei

Classe di Scienze Morali

Rome, Italy

ISBN 978-3-642-37313-8 ISBN 978-3-642-37314-5 (eBook)

DOI 10.1007/978-3-642-37314-5

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Library of Congress Control Number: 2013943689

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To the memory of my father

Edgardo Gandolfo

Preface

There is no lack of good international economics textbooks ranging from the

elementary to the advanced, so that an additional drop in this ocean calls for

an explanation. In the present writer’s opinion, there seems still to be room for

a textbook which can be used in both undergraduate and graduate courses and

which contains a wide range of topics, including those usually omitted from other

textbooks. These are the intentions behind the present book, which is an outcrop

from undergraduate and graduate courses in international economics that the author

has been holding at the Sapienza University of Rome and other universities from

1974 to 2010 and from his ongoing research work in this field.

Accordingly, the work is organised as two-books-in-one by distributing the

material between text and appendices.

The treatment in the text is directed to undergraduate students and is mainly

confined to graphic analysis and to some elementary algebra, but it is assumed that

the reader will have a basic knowledge of microeconomics (so that the usual review

material on production functions, indifference curves, etc. is omitted). Each chapter

has a mathematical appendix, where (i) the topics treated in the text are examined

at a level suitable for advanced undergraduate or first-year graduate students and

(ii) generalisations and/or topics not treated in the text (including some at the

frontiers of research, whose often obscure mathematical aspects are fully clarified)

are formally examined.

The text is self-contained, and the appendices can be read independently of

the text and can, therefore, also be used by students who already know ‘graphic’

international economics and want to learn something about its mathematical

counterpart. Of course the connections between text and appendices are carefully

indicated, so that the latter can be used as mathematical appendices by the student

who has mastered the text and the text can be used as graphic and literary exposition

of the results derived mathematically in the appendices by the student who has

mastered these.

The book is mainly analytical, although reality is present through sections on

the empirical verification of the main theories and through case studies and other

empirical materials contained in appropriate boxes. However, by stressing the

vii

viii Preface

analytical aspects, the author hopes to give the student the tools for an understanding

of facts and policies—tools that will survive the circumstances of the passing day.

This new edition has been thoroughly revised and enriched thanks to the

contributions by Professor Federico Trionfetti of Aix-Marseille University (Aix￾Marseille School of Economics), CNRS and EHESS, that bring the book up to date.

He has contributed sections of Chaps. 4, 9, and the entire Chaps. 16 and 17, plus

several minor revisions. He wishes to thank the participants in the Brixen Workshop

and Summer School 2012 as well as the master’s students of the Aix-Marseille

School of Economics for precious comments.

***

I am grateful to the students from all over the world who have written me over

the years to indicate unclear points and misprints of the previous editions and to

Marianna Belloc, Nicola Cetorelli, Giuseppe De Arcangelis, Vivek H. Dehejia,

Laura Sabani, and Francesca Sanna Randaccio, for their advice and comments. I

am particularly indebted to Daniela Federici, who has made very useful suggestions

as regards the new material, then checked it with painstaking care.

None of the persons mentioned have any responsibility for possible deficiencies

that might remain.

Rome, Italy Giancarlo Gandolfo

Contents

Part I Introduction

1 Introduction to International Trade Theory and Policy................ 3

1.1 International Economics as a Distinct Subject ...................... 3

1.2 The Theory and Policy of International Trade: An Overview...... 5

1.3 Small and Large Open Economies .................................. 6

References.................................................................... 7

Part II Foundations of Trade Theory

2 The Classical (Ricardo-Torrens) Theory of Comparative Costs ...... 11

2.1 Comparative Costs (Advantages) and International Trade ......... 11

2.2 Alternative Graphic Representations ................................ 14

2.3 A Modern Interpretation in Terms of Optimization ................ 19

2.3.1 Maximization of Real Income in Each Country........... 19

2.3.2 Maximization of Real World Income ...................... 21

2.4 Generalizations ....................................................... 23

2.4.1 Two Goods and n Countries................................ 24

2.4.2 m Goods and n Countries................................... 25

2.5 The Problem of the Determination of the Terms of Trade ......... 29

References.................................................................... 30

3 The Neoclassical Theory of International Trade ....................... 33

3.1 The Transformation Curve and the Box Diagram .................. 33

3.1.1 The Box Diagram........................................... 34

3.1.2 The Transformation Curve and Its Properties ............. 35

ix

x Contents

3.2 General Equilibrium in a Simple Closed Economy................. 39

3.2.1 The Supply Curves ......................................... 39

3.2.2 The Demand Curves........................................ 41

3.2.3 General Equilibrium and Walras’ Law .................... 42

3.3 General Equilibrium in Open Economies

and International Trade .............................................. 43

3.4 Offer Curves, International Equilibrium, and Stability ............. 47

3.4.1 Derivation of the Offer Curve .............................. 47

3.4.2 International Equilibrium and Stability.................... 49

3.5 Increasing Returns to Scale .......................................... 53

3.6 The Gains from Trade ................................................ 56

3.7 Generalizations ....................................................... 59

3.8 Duality Approach .................................................... 60

3.9 Empirical Studies..................................................... 61

References.................................................................... 61

4 The Heckscher-Ohlin Model .............................................. 63

4.1 Basic Assumptions and Their Meaning ............................. 63

4.1.1 Relative Price of Goods and Relative Price of Factors.... 67

4.2 The Heckscher-Ohlin Theorem ...................................... 69

4.3 Factor Price Equalization ............................................ 72

4.3.1 A Graphic Treatment ....................................... 74

4.3.2 The Factor Price Equalization Set ......................... 77

4.4 The Factor Content of Trade

and the Heckscher-Ohlin-Vanek Theorem .......................... 80

4.5 Extensions and Qualifications ....................................... 82

4.5.1 Non-identical Structures of Demand ...................... 83

4.5.2 Factor-Intensity Reversals.................................. 85

4.5.3 The Heckscher-Ohlin-Vanek Generalization .............. 87

4.6 Empirical Studies..................................................... 90

4.6.1 Leontief’s Paradox.......................................... 90

4.6.2 Explaining the Paradox ..................................... 91

4.6.3 What Paradox? There Is No Paradox ...................... 95

4.6.4 Factor Content of Trade Studies ........................... 97

4.6.5 Concluding Remarks ....................................... 99

References.................................................................... 100

5 The Four Core Theorems .................................................. 103

5.1 Introductory Remarks ................................................ 103

5.2 The Heckscher-Ohlin and Factor-Price-Equalization Theorems... 103

5.3 The Stolper-Samuelson Theorem.................................... 104

5.4 The Rybczynski Theorem............................................ 105

5.4.1 An Alternative Diagram .................................... 106

References.................................................................... 108

Contents xi

6 Some Refinements .......................................................... 109

6.1 Introduction ........................................................... 109

6.2 The Specific Factors Model.......................................... 109

6.3 Transport Costs and International Trade ............................ 114

6.4 Intermediate Goods .................................................. 118

6.4.1 Intermediate and Capital Goods

in the Neoclassical Theory ................................. 121

6.5 Elastic Factor Supply................................................. 123

6.6 Non-traded Goods.................................................... 124

6.7 Natural Resources, “Dutch Disease”, and De-industrialization .... 128

6.8 International Factor Mobility and Trade in Factors................. 134

6.8.1 Factor Mobility, and the Theorems

of International Trade ...................................... 135

6.8.2 International Movements of Labour (Migration).......... 139

6.8.3 International Movements of Capital ....................... 140

6.8.4 Foreign Direct Investment and Multinational

Corporations ................................................ 141

6.8.5 Offshoring................................................... 145

6.8.6 Factor Trade................................................. 148

6.9 International Trade under Uncertainty .............................. 148

6.10 Illegal International Trade and the Economic Theory

of Smuggling ......................................................... 150

References.................................................................... 154

Part III New Explanations for International Trade

7 An Overview ................................................................ 159

7.1 Introduction ........................................................... 159

7.2 Theory ................................................................ 162

7.3 Policy ................................................................. 163

7.4 Growth ................................................................ 163

7.5 Location Theory and Trade .......................................... 164

References.................................................................... 164

8 The Precursors.............................................................. 165

8.1 Availability ........................................................... 165

8.2 Technology Gaps ..................................................... 166

8.3 The Product Cycle.................................................... 167

8.4 Income Effects........................................................ 169

8.4.1 Linder’s Theory ............................................. 169

8.4.2 Barker’s Variety Hypothesis ............................... 170

8.5 Intra-industry Trade or, the Traditional Theory Strikes Back ...... 172

8.5.1 Perfectly Homogeneous Goods ............................ 173

8.5.2 Differentiated Products..................................... 174

References.................................................................... 176

xii Contents

9 The Models .................................................................. 177

9.1 Neo-Heckscher-Ohlin Theories...................................... 177

9.2 Monopolistic Competition and International Trade ................ 179

9.2.1 The Krugman Model ....................................... 180

9.2.2 A Simple Synthesis Model ................................. 186

9.2.3 Monopolistic Competition and Welfare

Effects of Trade Opening................................... 189

9.2.4 The Home Market Effect ................................... 190

9.2.5 Adding Some Realism to the Monopolistic

Competition Model ......................................... 195

9.2.6 The Gravity Equation....................................... 197

9.2.7 Heterogeneous Firms ....................................... 197

9.3 Oligopoly and International Trade................................... 202

9.3.1 Introduction ................................................. 202

9.3.2 Homogeneous Commodities ............................... 202

9.3.3 Vertically Differentiated Goods............................ 204

9.3.4 Horizontally Differentiated Goods......................... 206

9.4 Empirical Studies in the Light of Theory ........................... 207

References.................................................................... 210

Part IV Trade Policy

10 Tariff and Non-tariff Barriers............................................. 215

10.1 Introduction ........................................................... 215

10.2 GATT and WTO...................................................... 216

10.3 Partial Equilibrium Effects of a Tariff ............................... 218

10.4 The Social Costs of a Tariff .......................................... 220

10.5 General Equilibrium Effects of a Tariff ............................. 223

10.5.1 The Production-Possibility Frontier and Tariffs........... 223

10.5.2 Tariffs and Reciprocal Demand Curves ................... 226

10.6 Quotas and Other Non-tariff Barriers ............................... 230

10.6.1 Quotas....................................................... 231

10.6.2 Export Duties ............................................... 233

10.6.3 International Cartels ........................................ 234

10.6.4 Other Impediments to Free Trade .......................... 239

10.7 Intermediate Goods and Effective Rate of Protection .............. 242

10.8 Imperfect Competition and Trade Policy............................ 245

10.8.1 A Tariff Under Vertical Product Differentiation .......... 246

10.8.2 Monopolistic Competition

and Welfare-Improving Tariff .............................. 247

10.8.3 Strategic Trade Policy Under Oligopoly

with Homogeneous Good .................................. 247

10.8.4 Strategic Trade Policy Under Oligopoly

with Differentiated Good ................................... 248

References.................................................................... 250

Contents xiii

11 Free Trade vs. Protection, and Preferential Trade Cooperation ...... 253

11.1 The Optimum Tariff .................................................. 254

11.2 The Infant Industry ................................................... 256

11.3 Distortions in Domestic Goods Markets ............................ 258

11.4 Distortions in Domestic Factor Markets ............................ 261

11.5 Non-economic Motives for Protection .............................. 263

11.6 The Theory of Second Best .......................................... 263

11.7 Preferential Trading Cooperation.................................... 265

11.7.1 The Various Degrees of Cooperation ...................... 265

11.7.2 The Effects of a Customs Union ........................... 266

11.7.3 Empirical Problems......................................... 271

11.8 The Main Cases of Preferential Trading Cooperation .............. 272

11.8.1 The European Common Market (Now

European Union)............................................ 272

11.8.2 NAFTA ...................................................... 273

11.8.3 MERCOSUR ............................................... 274

11.8.4 ASEAN ..................................................... 274

11.8.5 FTAA........................................................ 274

References.................................................................... 274

12 The “New” Protectionism ................................................. 277

12.1 Introductory Remarks ................................................ 277

12.2 Why the New Protectionism? ........................................ 277

12.3 Voluntary Export Restraints and Import Expansion ................ 278

12.4 Subsidies.............................................................. 280

12.5 The Political Economy of Protectionism............................ 282

12.5.1 The Demand for and Supply of Protection ................ 283

12.6 Administered and Contingent Protection, and Fair Trade .......... 285

12.6.1 Dumping and Antidumping ................................ 287

12.6.2 Countervailing Duty ........................................ 291

12.6.3 Safeguard Actions .......................................... 294

References.................................................................... 295

Part V Growth and Trade

13 International Trade and Growth: Comparative Statics ................ 299

13.1 Introduction ........................................................... 299

13.2 The Effects of Growth on the Volume of Trade..................... 300

13.2.1 Consumption Effects ....................................... 300

13.2.2 Production Effects .......................................... 302

13.2.3 A Reformulation in Terms of Elasticities:

The Total Effect............................................. 303

13.3 Growth and Terms of Trade: Immiserizing Growth ................ 305

13.3.1 The Large Country and the Terms of Trade ............... 305

13.3.2 Immiserizing Growth ....................................... 307

xiv Contents

13.4 Increase in Factor Endowments and International

Trade: Rybczynski’s Theorem ....................................... 309

13.5 Technical Progress and International Trade ......................... 310

13.5.1 Types of Technical Progress ............................... 310

13.5.2 Effects of Neutral Technical Progress

on Production Levels and the Terms of Trade ............. 312

13.5.3 Effects of Biased Technical Progress ...................... 315

13.5.4 Conclusion .................................................. 319

References.................................................................... 319

14 International Trade and Growth: Dynamics ............................ 321

14.1 Dynamic Models ..................................................... 321

14.2 A Simple Closed-Economy Two-Sector Growth Model ........... 322

14.3 Extension to an Open Economy ..................................... 325

References.................................................................... 327

15 Endogenous Growth and Trade, Old and New .......................... 329

15.1 Introduction ........................................................... 329

15.2 A Small Open Economy with Endogenous Technical Progress.... 330

15.3 Endogenous Growth, North-South Trade and Imitation:

A New Version of the Product Cycle ................................ 331

References.................................................................... 334

Part VI Globalization

16 Globalization and Economic Geography................................. 337

16.1 Introductory Remarks ................................................ 337

16.2 Transport Cost, Location Theory, and Comparative Advantage ... 338

16.3 The Core-Periphery Model .......................................... 340

16.3.1 Description of the Model ................................... 341

16.3.2 Conclusion .................................................. 348

16.4 Other Models ......................................................... 349

16.4.1 Housing Congestion ........................................ 349

16.4.2 Input-Output Linkages ..................................... 352

16.4.3 Diminishing Returns to Labour in the A Sector........... 355

16.4.4 Footloose Capital ........................................... 356

16.5 Too Much or Too Little Agglomeration?............................ 358

16.6 Conclusion ............................................................ 361

References.................................................................... 363

17 Trade Integration and Wage Inequality.................................. 365

17.1 Introduction ........................................................... 365

17.2 Comparative Advantage, Technical Change, and the

Skill Premium ........................................................ 366

17.2.1 Trade Integration ........................................... 366

17.2.2 Technical Change ........................................... 367