Relationship between international factors movement

and international trade

Substitution

• Assume labor moves from china into U.S.

• After the immigration, China will produce less labor-intensive products while the US will produce more labor-intensive commodities.

• This implies that international trade between the two countries will shrink.

Mundell (1959,AER) Model

• Assumptions:• 2 by 2 model• Produce steel and cotton• China is labor abundant but small country• US is capital abundant and large country• Identical technology• Factors are perfectly mobile between the

two countries.

• Assume factors are perfectly immobile first, but we allow free trade.

• If China imposes a high import tariff on steel, then what happens to the interest rate which is the return on the capital?

china

• C p’

• P

• D

• Y

Recall Stolper-Samuleson Theorem

• An increase of the relative price of a commodity will increase the real return of the factor used intensively in that product.

• Price of steel up r up

• An increase of price of the steel steel production raises require more capital excess demand exists pushes up capital price.

• Rch > Rus

• Capital flows into China

• China’s PPF outshifts

• Capital outflow does not affect US’s MPK.

• Eventually, China’s MPK should equal US’s MPK

• China’s final relative price ratio should be identical to its original price ratio.

• Production in China increases, but welfare is still the same since we have to pay the interest to the foreign country.

• Hence, they exist a substitute relationship between factor movement and international trade.

• Markuson (1983) : international factor movement and trade are complement instead of substitution by assuming heterogeneous technology across countries !