Chapter Introduction
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Gains and Losses from Trade in the Specific-Factors Model
This chapter develops the fixed-factors model to introduce the important idea that although trade may make the economy as a whole better off, it benefits some people and hurts others. The theme of the distributional effects of trade will be reappear in the HO model.
- Specific-Factors Model
- Earnings of Labor
- Earnings of Capital and Land
- Conclusions
1. Recent Bolivian experience as an example of how gains from trade are not shared equally
2. Key lesson of the chapter: Trade creates winners and losers. In the Ricardian model everyone gained since there was only one factor of production. If there are other factors then the owners of some factors benefit from trade, while others are hurt.
3. The specific-factors model assumes two sectors, agriculture and manufacturing, and three factors of production, land, labor, and capital. Labor is used in both sectors, but land is specific to agriculture, while capital is specific to manufacturing. Who gains and who loses from trade?
4. Specificity is reasonable in the short run, since it is costly to shift land and capital quickly across sectors. However, it may not be reasonable over the long run. Specific-factors is a short-run model; later chapters will develop a long-run model that allows complete factor mobility across sectors.
The time has come, the awaited day, a historic day in which Bolivia retakes absolute control of our natural resources.
Evo Morales, President of Bolivia, 20061
If we do not take action, those who have the most reason to be dissatisfied with our present rate of growth will be tempted to seek shortsighted and narrow solutions—to resist automation, to reduce the work week to 35 hours or even lower, to shut out imports, or to raise prices in a vain effort to obtain full capacity profits on under-capacity operations. But these are all self-defeating expedients which can only restrict the economy, not expand it.
President John F. Kennedy, New York Economic Club, 1962
Over the span of three years, 2003 to 2005, Bolivia had three presidents. This rapid succession at the highest level of government was largely a result of public dissatisfaction with the distribution of gains that had come from exporting natural gas. Many people, including the indigenous Aymara Indians, believed that most of these gains had gone to multinational oil corporations, with little distributed to the citizens of the country in which the gas deposits and refineries are located.
Violent protests in September 2003 led to the resignation of President Gonzalo Sánchez de Lozada, who was replaced by Carlos Mesa, a writer and television journalist. He promised to respect the views of the indigenous people of Bolivia and in July 2004 held a referendum on whether the country should export natural gas. The referendum included provisions to ensure that more of the profits from natural gas exports would go to the Bolivian government rather than to foreign companies. With these assurances, the referendum passed, and in May 2005 taxes on foreign oil companies were sharply increased. But many protestors wanted more and forced President Mesa to resign within the year. Elections were held again in December 2005, and Evo Morales scored a decisive victory, becoming the first Aymara Indian elected to president in Bolivia’s 180-year history. In May 2006 he nationalized the gas industry, which meant that all natural gas resources were placed under the control of the state-owned energy company. With this policy change, foreign investors lost their majority ownership claims to gas fields, pipelines, and refineries that they had built and lost a significant portion of the profits from the sales of Bolivian natural gas. This drastic step, which was criticized heavily by foreign governments, was supported by people in Bolivia. Because of this and other popular policies, Evo Morales was re-elected in 2009 for another five-year term. As of 2013, the gas industry in Bolivia is still largely owned by the state.
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The Bolivian experience illustrates the difficulty of ensuring that all people within a country share in the gains from trade. Despite the abundant natural gas resources along with other minerals such as silver, tin and lithium—used to make car batteries—many of the local population remained in poverty. The difficulty of sharing these gains among Bolivia’s citizenry makes the export of gas a contentious issue. Although the export of natural gas clearly generated gains for the foreign-owned and state-owned companies that sold the resources, the indigenous peoples did not historically share in those gains.
A new constitution in 2009 gave indigenous peoples control over natural resources in their territories. Companies from Japan and Europe made deals with the Morales government to extract this resource, but the government ensured that the gains flowed to the local population through poverty reduction programs. Since 2009, Bolivia has experienced high economic growth, averaging 4.7% over the past five years. There has been substantial migration from indigenous rural locations to cities such as El Alto, which was formerly the site of violent protests, but now is host to thriving small businesses owned by men and women.2
A key lesson from this chapter is that in most cases, opening a country to trade generates winners and losers. In general, the gains of those who benefit from trade exceed the losses of those who are harmed, and in this sense there are overall gains from trade. That was a lesson from the Ricardian model in the last chapter. But our argument in the last chapter that trade generates gains for all workers was too simple because, in the Ricardian model, labor is the only factor of production. Once we make the more realistic assumption that capital and land are also factors of production, then trade generates gains for some factors and losses for others. Our goal in this chapter is to determine who gains and who loses from trade and under what circumstances.
The model we use to analyze the role of international trade in determining the earnings of labor, land, and capital assumes that one industry (agriculture) uses labor and land and the other industry (manufacturing) uses labor and capital. This model is sometimes called the specific-factors model because land is specific to the agriculture sector and capital is specific to the manufacturing sector; labor is used in both sectors, so it is not specific to either one. The idea that land is specific to agriculture and that capital is specific to manufacturing might be true in the short run but does not really hold in the long run. In later chapters, we develop a long-run model, in which capital and other resources can be shifted from use in one industry to use in another. For now we focus on the short-run specific-factors model, which offers many new insights about the gains from trade beyond those obtained from the Ricardian model.
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