In-Depth Notes on International Trade Theories and Income Inequality

Three Theories of International Trade

  • Neoclassical Model (Smith, Ricardo, Heckscher-Ohlin)

    • Pros:
    • Explains patterns of international trade through comparative advantage.
    • Countries specialize based on comparative advantages (e.g., oil, bananas).
    • Heckscher-Ohlin Theory (H-O):
    • Factor endowment theory: countries specialize and export based on labor and capital endowments.
    • Cons:
    • Static model; assumes country's comparative advantage remains unchanged, which can lead to divergence.

  • Vernon’s Product Life Cycle (1966)

    • Pros:
    • Dynamic model where countries can change productivity over time.
    • Product Space: Transition from new products (innovated in high-income countries) to standardized products (produced in low-income countries).
    • Cons:
    • The model explains economic convergence but lacks in addressing divergence.
Porter’s Competitive Advantage of Nations (1990)
  • New Trade Theory (Krugman, Young)
    • Pros:
    • Introduces technology change in trade theory, leading to differentiation between countries.
    • NORTH: Focus on innovation, exports new products and technologies.
    • SOUTH: Focus on standardized products through exports.
    • Knowledge spillovers contribute to convergence and divergence between North and South (Romer's theory states increasing knowledge leads to economic growth).
    • Porter’s Diamond of National Advantage:
    • Factor Conditions: Nations create factors for competitiveness, rather than inheriting them.
    • Demand Conditions: Local demand that encourages firms to innovate and upgrade.
    • Related and Supporting Industries: Presence of related industries strengthens competitive advantage.
Autarky & National Treatment
  • Autarky:
    • Domestic inventors have patent protection only in their home market, leading to potential lack of incentive to innovate if the domestic market is small.
    • Issues arise in small countries where innovation may not be economically viable.
  • National Treatment (Treaty of Paris 1883):
    • Foreign inventors receive the same patent protection as domestic ones, providing an incentive to innovate due to expected profits.
    • Pros: Increases overall market and encourages innovation, but can lack uniformity across nations.
Harmonization & TRIPS (1994)
  • TRIPS Agreement: Sets a standard for intellectual property rights (IPRs), with a uniform duration of 20 years for patents.
  • Free Rider Problem: Consumer behavior in different regions highlights the uneven benefits from innovation versus patent costs.
  • Pros & Cons of TRIPS:
    • Pros: Stricter IPRs may promote economic growth, but developing countries face challenges in enforcing these due to lack of resources and specialized knowledge.
    • Cons: Claims that TRIPS has disproportionately benefited developed nations at the expense of developing ones.
Theories Explaining Income Inequality in U.S.
  • Income inequality linked to wage differentials between low-skilled and high-skilled workers.
  • Globalization (H-O Model): U.S. specializes in capital-intensive goods, reducing demand for low-skilled labor.
    • After China’s entry into WTO, labor-intensive exports increased, further displacing low-skilled jobs in the U.S.
Median Workers & Technological Advances
  • Demand for Tailored Services: Increased personalized services demands skilled labor; shift in demand due to the internet.
  • Skill-Biased Technological Change:
    • Higher demand for high-skilled workers complements technology; low-skilled jobs decline as they become redundant.
  • Wage Differential Trends:
    • Productivity gains favor capital owners more than workers, contributing to wage stagnation among median workers, despite overall economic growth.
Conclusion - Labor vs. Capital
  • Capital has increasingly benefited from technological advancements, with decreasing wage shares in GDP for labor due to various factors including diminished labor force participation and lower wages.