Lecture 6 ricardo model relative wages and productivity
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Lecture 6: Ricardo model: Relative wages and productivity. ECO 324F. Structure. Wages and productivity Limitations of Ricardo Model Empirical evidence Readings Ch 1 & 2 of Krugman and Obstfeld Golub, S. 1998. Does trade with low wage economies hurt American workers ?

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Structure

Structure

Wages and productivity

Limitations of Ricardo Model

Empirical evidence

Readings

Ch 1 & 2 of Krugman and Obstfeld

Golub, S. 1998. Does trade with low wage economies hurt American workers?

Edwards, L & Golub, S. 2003. South Africa’s international cost competitiveness: A sectoral analysis.

Krugman. P. Ricardo’s difficult idea


Question

Question

Can South Africa compete against China where wages are between 5 and 10 times lower?

Will trade force down SA workers wages down to those of China?

Some views:

“Companies that produce goods in foreign countries to take advantage of cheap labor should not be permitted to dictate the wages paid to American workers”

“Impose a tax or tariff on goods brought into this country equal to the wage difference”

Quotes cited in Golub (1998)

What are your views on this?

Can the Ricardo model provide any insight into this?


Discussion
Discussion

  • Golub (1998)

    • Wages are determined by absolute advantage

    • Trade is determined by comparative advantage

  • What is cost of product?

    • Cost = Price = wage/MPL


South african cost competitiveness

SA vs DEVELOPED Countries

0.6

0.5

0.4

0.3

0.2

0.1

0

1970-79

1980-89

1990-94

1995-98

wages

productivity

South African cost competitiveness

Source: Edwards and Golub (2003)


South african cost competitiveness1

SA against DEVELOPING Countries

3.5

3

2.5

2

1.5

1

0.5

0

1970-79

1980-89

1990-94

1995-98

wages

productivity

South African cost competitiveness

Source: Edwards and Golub (2003)



Data recap

Data recap relative productivity under trade

marginal products of labour per working hour

Industry Home Foreign

X (coffee) ah = 1 af = 1/6

Y (cloth) bh = 1/2 bf = 1/3

When: 1/2 < PX/PY < 2 :

Home specializes in X & Foreign specializes in Y

Other insights?

Home: 6 times as productive in X (MPLXH/MPLXF)

Home: 1.5 times as productive in Y (MPLYH/MPLYF)


Relative wages

Relative wages relative productivity under trade

New world price ratio P* = 1

Assume: price of X = R 30 = price of Y

What is the wage in each country?

Wage = MPL * Price

Home: WH = MPLX *PriceX = 1*R30 = R30

Foreign: WF = MPLY *PriceY = 1/3*R30 = R10

Relative wage: WH/WF = R30/R10 = 3


Lets plot relative wages relative productivity

Relative wage = 3 relative productivity under trade

Relative productivity in Y = 1.5

Relative productivity in X = 6

Lets plot relative wages & relative productivity

Relative wage is between productivity ratios:

Each country has Cost Advantage in production

Home:

in X: 6 times more efficient but only 3 times more expensive

Foreign:

in Y: 1.5 times less efficient but 3 times cheaper

Solution:

Each product gets produced where it is the cheapest to produce!


Sub conclusion

Sub-conclusion relative productivity under trade

Trade is dependent on the relationship between relative wages and relative productivity

Export products where

Relative wage < relative productivity

Import products where

Relative wage > Relative productivity


What happens if p rises

Relative wage = 3 relative productivity under trade

Relative productivity in Y = 1.5

Relative productivity in X = 6

What happens if P* rises

Assume Px rises to R60, i.e. P* rises to 2

Home: WH = MPLX *PriceX = 1*R60 = R60

Foreign: WF = MPLY *PriceY = 1/3*R30 = R10

Relative wages (WH/WF) rise to 6

As shown using graphs, an improvement in TOT raises a country’s relative wage


What happens if productivity rises

What happens if productivity rises? relative productivity under trade

Is rapid technological progress in China a threat to welfare in South Africa?

Assume Px = PY = R30, i.e. P* =1

Let productivty of H triple.

Home: WH = MPLX *PriceX = 3*R30 = R90

Foreign: WF = MPLY *PriceY = 1/3*R30 = R10

Relative wages (WH/WF) rise to 9

IS that the final effect?


Do the results change if we introduce multiple goods

Do the results change if we introduce Multiple Goods? relative productivity under trade

marginal products of labour per working hour

Industry Home Foreign Rel Prod

X (coffee) ah = 1 af = 1/6 6

Y (cloth) bh = 1/2 bf = 1/3 1.5

Z (apples) 10 1 1

W (leather) 1 1 1

Order these by tatios of industries' productivities:

MPL1H/MPL1F < MPL2H/MPL2F < … < MPLnH/MPLnF

And plot on the relative w and relative productivity scale


Multiple goods model

1.5 relative productivity under trade

10

1

6

Relative productivity in W (leather)

Relative productivity in Y (cloth)

Relative productivity in X (coffee)

Relative productivity in Z (apples)

Increasing relative productivity of Home

If relative wage (WH/WF) lie here, then Home exports coffee and apples and imports cloth and leather

If relative wages (WH/WF) fall to here, then Home exports coffee, apples and cloth and imports leather

Multiple Goods model

Relative wage = WH/WF


Sub conclusions

Sub-conclusions relative productivity under trade

The competitiveness of an industry depends not only on relative wages but also on relative productivity

Relative wages generally follow relative productivity

Export products where relative productivity > relative wages

Declining terms of trade (Pexport/Pimport) negatively affect relative wages


Limitations of model

Limitations of model relative productivity under trade

What are the limitations of model?

Model assumes full specialization

What are the sources of labour productivity? Capital?

Need to include other factors of production

What about transport costs?

Income distribution: Model predicts that all factors gain

Cannot explain intra-industry trade


Transport costs

Transport costs relative productivity under trade

Transport costs:

Home: Px = R 30 Py = R 60

Foreign: Py = R 30

Home imports Y from Foreign

But:

if transport cost = 110% of Py (foreign)

Imported Y costs: R30 + (R30 *110%) = R63

Imported Y is more expensive than Home Y

Py (foreign) = R63 > R60 (Home Y)

Outcome:

Home will not import Y from foreign and rather produce Y itself

Y becomes a NONTRADED GOOD like hair-cuts


Schematic transport costs

Relative productivity in W (leather) relative productivity under trade

Relative productivity in Y (cloth)

Relative productivity in X (coffee)

Relative productivity in Z (apples)

Non-tradable products

Schematic: Transport costs

Relative wage = WH/WF

With transport costs goods at the margin no longer become profitable to trade


Empirical evidence

Empirical evidence relative productivity under trade

Is there any support for the Ricardo model? i.e. Does it predict trade flows?

Read

Golub, S. 1998. Does trade with low wage economies hurt American workers?

Edwards, L & Golub, S. 2003. South Africa’s international cost competitiveness: A sectoral analysis.


Does sa cost competitiveness affect exports
Does SA cost competitiveness affect exports? relative productivity under trade

1970-79

1980-89

3.00

2.00

1.80

2.50

1.60

1.40

2.00

1.20

RULC

1.50

RULC

1.00

0.80

1.00

0.60

0.40

0.50

0.20

0.00

0.00

0

500

1000

1500

2000

2500

3000

3500

0

500

1000

1500

2000

2500

3000

3500

4000

Real exports (R million)

Real exports (R million)

1990-98

1990-98

2.00

2.00

1.80

1.80

1.60

1.60

1.40

1.40

1.20

1.20

RULC

1.00

RULC

1.00

0.80

0.80

0.60

0.60

0.40

0.40

0.20

0.20

0.00

0.00

0

1000

2000

3000

4000

5000

6000

7000

0.00

0.10

0.20

0.30

0.40

0.50

0.60

Real exports (R million)

Exports/Output


Does sa cost competitiveness affect exports1

Does SA cost competitiveness affect exports? relative productivity under trade

Source: Edwards and Golub (2003)


Conclusion
Conclusion relative productivity under trade

International competitiveness

  • SA competitive, as measured by RULC, in most sectors vis-à-vis developed countries, but not developing countries

  • SA competitiveness improved during the 1990s

  • but improvement substantially reflects the large depreciation of the rand against other currencies

  • No clear pattern of competitiveness at the sectoral level over time

    Effect of competitiveness on exports

  • South African exports respond strongly to labor cost competitiveness (relative wages and relative productivity) (particularly L-intensive)

  • Growth in exports during the 1990s in large measure due to improved relative unit labor costs


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