Globalization, Growth, and Trade

Lectures 15-16: More on Specific Factors Model

(SFM) &Dutch Disease

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2

L

L

M

XXT

MT

LT

p*

uT

0

LA

MA

XA

uA

pA

Lm

Lx

• •

•

•

•

•

•

•

•

Review of SFM Model

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L

L

M

X

45o

LA

LT

pA

pT

0

MA

MT

XA

XT

slope = (w/pM)A

(w/pM)T

YTYA

Changes in Factor Earnings (A->T)

Gains and losses from trade in SFMNominal factor returns: w, rX, rM

Real factor incomes: relative to index of all consumer prices, such as CPI = px

apm1-a , a = budget share of X

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Effect of a rise in px/pm on:

Capitalists (Km)

Landowners (Kx)

Workers

(L)

Nominal income lose gain gain

Real income:

If a 1 lose gain lose?

If a 0 lose gain gain?

Growth and policy experiments

Growth: What happens when the labor force grows? When either sector’s capital stock expands?

Related questions: Productivity improvement: What happens when

producers adopt new, improved technologies?Policies: What happens when integration with world

market is conditioned, e.g. by a tariff?Effects on production, resource allocation, aggregate

income, income distribution?

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6

0 L0 L

Y

Y0

0 L0 L

Y

Y0

Labor force growth Sectoral capital growthL1

Y1

Y1

What happens when the labor force grows? When either sector’s capital stock expands?

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M

X

p = –px/pm

q1 •

• Labor force growth increases maximum achievable production in each sector (PPF shift need not be symmetric)•  As drawn here, which sector is relatively labor-intensive? Why?• At constant p, what happens to real factor returns?

• Labor force growth increases maximum achievable production in each sector (PPF shift need not be symmetric)•  As drawn here, which sector is relatively labor-intensive? Why?• At constant p, what happens to real factor returns?

q2 •

• u2

• u1

Labor Force Growth and the PPF

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L

L

M

XXT

MT

LT

pT

uT

uT

Labor Force Growth and Income

Labor force growth and income distribution

When the labor force grows but capital remains fixed in each sector, what happens to wages?

What happens to returns to specific factors?

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M

X

• u1

p = –px/pm

q1

• Growth of endowment of sp. factor in exportables increases maximum achievable production in that sector only. •  Rybczinski effect: output of M sector must decline (why?)• At constant p, what happens to real factor returns?

• Growth of endowment of sp. factor in exportables increases maximum achievable production in that sector only. •  Rybczinski effect: output of M sector must decline (why?)• At constant p, what happens to real factor returns?

• u2

q1 •q2 •

Specific Factor Growth (FDI) and PPF

SE Asia: growth & dev. in open economies

Thailand’s trade and FDI-driven economic boom

Indonesia’s oil wealth and “Dutch Disease”

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Manufactured exports - developing countries

Which countries industrialize, and why?Endowments: cheap labor, infrastructure,

resource-scarce (?)Relatively stable macroeconomic & political

conditionsLower barriers to investment and importation of

inputsEarly industrializers: Japan, Taiwan, Korea…

Size of domestic market prohibited closed-economy growth export orientation

Capital raised from domestic savingsLater industrializers: Thailand, Malaysia, VN

Same export orientation, but using foreign capital

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Thailand: growth & poverty decline

In Thailand, growth was really fast in 1985-97

During this decade, trade/GDP rose and so did FDI/GDP, especially from E. Asia

Poverty also declined very fast Inequality did not increase much

Can we use SFM to understand these trends?

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What factors contribute to poverty decline?

1. Overall economic growth

2. Direct anti-poverty policies

3. Indirect effects of international integration Job creation, esp. low-skilled labor Internal migration

Wage effects Remittances

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Thailand: direct anti-poverty policies

Policies addressing opportunity, security, and community Opportunity: increasing labor productivity

through education and trainingSecurity: stabilizing incomes against shocks

(e.g. economic recessions)Community: building local capacity for

economic development and protection for poorThese direct policies had only mixed success

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Indirect policies: globalization as anti-poverty measure

Globalization after about 1984:FDI inflowsTrade liberalizationOther pro-trade measures

Job creation through FDI and specialization in L-intensive tradables sectorsChange in structure of exports and employment: gr

of L-intensive mfgTransmission of gains: wage growth in non-ag and

in ag/rural areasThese structural changes associated with

globalization appear to account for the largest share of poverty alleviation progress in Thailand

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Economy-wide spread of wage growth

Conclusions: Thailand Labor-intensive growth, e.g. of

manufacturing, has direct and immediate effects on poverty

FDI was mostly efficiency-seeking: E. Asian manufacturers looking for cheap labor

FDI increased stock of manufacturing sector capital

This raised total labor demand and encouraged rural-urban migration (spread of gains)

With prices mostly stable, real wages increased steadily through early 1990s

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Break time!

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Resource Curse: Overview(http://en.wikipedia.org/wiki/Resource_c

urse)

Countries with rich natural resource bases have worse growth and development outcomes. Why?

One reason: “Dutch Disease”:1960s: Oil/gas discoveries by HollandHuge export “boom” from oil/gas sales, but…Severe domestic inflationLoss of manufacturing jobs and investmentSame phenomenon seen in other oil-rich countriesAre these changes all linked?

Specific factors model: increase in natural resource capital… effects on economy?

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Nontraded goods and “real exchange rate”

SFM can explain structural change but not inflation

Need a 3rd sector – nontraded goods, with prices endogenous

Examples of NT goods; characteristics of marketsGoods may be non-traded (or effectively so) for intrinsic

reasons, or because of policy interventions D=S in domestic market; price must adjust to clear market

Demand for NT goods is usually elastic w.r.t. income growthTherefore, rise in income means rise in pN/pX and pN/pM

Why do we care?

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Demand and Supply in T and NT SectorsNon-Tradable Sector Tradable sector

P

Q

SD

p*

q*

D’

p’

q’

S slopes up and p NT rises w/

increase in demand.

Q

PD

D’

S

S is flat because p in T sector isset in world markets.

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The ‘real’ exchange rate

Real exchange rate = price of N goods in terms of all T goods (= pN/pT)RER is endogenous, even if prices of all T

goods set in world mkts (‘small country assumption’)

It conveys effects of changes in one sector, or in aggregate income, to other sectors Directly, through relative price changes Indirectly, through changes in factor prices

RER rise: indicator of inflation relative to other countries --> changes in relative production costs

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(yT, yN) = (cT, cN)

RER = -pN/pT

N

T

Note: All tradable goods in one index, on vertical axis27

2. Resource wealth

Many dev. econs have relatively large resource sectors (minerals, agric., forestry) producing commodities for export to world mkts

These sectors & their global markets have special characteristics-- incl. volatility

What happens to the structure and performance of the economy when a resource sector experiences a “boom” (price rise, new reserve discovery, tech change)?

What are the contradictions/risks of rapidly rising income from a single booming sector?

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What do you think?

‘Income effect’: new income raises spending across the boardRise in N prices: domestic inflation, wage rises

Loss in profitability and jobs in T goods other than the ‘booming’ sector

Boom in gov’t revenues and spendingG. consumption or investment?

What about changes in factor returns?Labor, ‘capital’ in booming sector, etc.income distribution?

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Dutch Disease

Could a natural resource boom lead to “deindustrialization” (or “deagriculturalization”)?Why would a country like Venezuela export

only oil products and import basic goods like eggs?

Why did Nigeria’s export agriculture sectors collapse in the 1980s, and what were the consequences for incomes, welfare and poverty?

Why is Indonesia’s manufacturing sector now failing to grow?

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3. Resource Boom Model

3 Sectors:1. Resource sector (oil, natural gas) - X2. Tradable (Ag, Manuf) – M3. All tradables together: T, so LT = LM + LX

4. Non-tradable (services, land) - NTExample (NT): Haircuts, restaurants,

health, educ.

Small open economy, one mobile factor – laborX production uses a specific factor (oil reserves,

mineral reserves), M and N both use specific capital.

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LTLNT

Economy-wide labor allocation before energy export boom

WO

WW

LNT LT

LM

L0 a

1. LNTL0 is labor in NT production

2. LTL0 is total labor in T prod’n

3. LTa is labor in manuf production

4. aL0 is labor in energy sector

5. w0 is econ-wide wage rate

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LTLNT

Labor allocation after the boom: resource movement effect

W1

w0

W W

LNT LT

LM

L1 L0 a b

1. LNTL1 is labor in NT production

2. LTL1 is total labor in T prod’n

3. LTb is labor in manuf production

4. bL1 is labor in energy sector

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LTLNT

Labor allocation after the boom: incomes spending effect

W2

W1

w0

W W

LNT LT

LM

L1 L0 a b c

1. New spending raises pNT

2. Lab demand in

NT rises to LNT’

3. Higher wages & labor costs for

all industries

4. Manuf sector costs rise, output falls

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LNT’

Implications of Dutch Disease

Increased Dependence on Boom and Non-Tradable (NT) SectorsIncreased vulnerability to price shocksWorld commodity markets are very volatileNT sector adjusts through prices more than quantitiesHigher risks of macro instability

Rising NT prices means inflation and speculation (property booms, unproductive investments)

Decline of tradable sector Loss of comparative advantage is traditional industries

(Nigeria palm oil)May reduce potential for dynamic growth in manuf

industries35

Resource Curse:Lack of Diversification

Basic logic of why?Dutch Disease model explainsExpectations of easy wealthIncentives for entrepreneurs and innovators

shifted to wealth-grabbingEvidence of lack of diversification (boom sectors

dominating exports, Boom and non-tradables sector

dominating GDP)

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Empirical Evidence on Lack of Diversification

Nigeria Petroleum, 95% exports, 20%

GDP, once a food exporter now importer,

70% labor in agriculture, 17% of GDP.

Ecuador Petroleum, 56% of exports,

Bananas 12% Oil-mining, 24% of GDP Ag 6% GDP, 8% of labor Services 60% of GDP, 68% of

LaborIran

Petroleum, 80% of exports, Ag 11% of GDP 30% of labor Unemployment 20% 37

Resource Curse: Rent-Seeking Behavior

Huge incentives to capture the “rents” (excess profits of resources). Foreign exploitation potential is high. Ex: $80/bbl of oil versus $8/bbl prod costs. Rents = Super-normal profits

Political economy of country dominated by efforts to control & capture rents.

Crowds out other kinds of political and economic initiatives.

Conflict becomes central (as does potential for dictators or authoritarian regimes).

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Resource Curse:Feeble Taxation Systems

State control of resources (nationalization or taxation) reduces need for development of other tax systems. Oil-rich countries get almost all of their government

revenues from state oil company or taxes.Lack of public commitment to taxation system makes

government vulnerable to volatile prices of oil or other leading resource.

Also undercuts commitment to public expenditures. Low investment in public education common in resource

rich countries (competitiveness of workers lower priority when resource rents are main source of wealth).

Low commitment to democracy as well if public sector not viewed as carrying out allocation of people’s tax revenues.

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Resource Riches Not Always a Curse

Empirical examples U.S., Canada, Australia Chile (copper, fruits, lumber) Norway and Sweden Botswana Malaysia Brazil Vietnam?

Why? Types of resource riches (ag/ind. Links) Types of institutions in place Size of economy/diversity of production sectors Timing of booms Policy choices

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Summing up

Growth and globalization have a complex relationship

Understanding these requires careful analysisSimple models – heuristic devices (road maps)

Heckscher-Ohlin – ‘benchmark’ modelSFM: Extends H-O to take account of realities

(natural resources, limited adjustment capacity)Dutch Disease model: introduces macroeconomic

dimension with endogenous prices and many more development/political economy stories

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Looking forward

Tomorrow – quiz only

Next week – one meeting (return hwks and quizzes; discuss as needed)

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