Specific Factor model 2

1
Specific Factor model 2

• Eco 324F

2
Welfare implications of trade
3
Structure

• Finish Specific Factor model
• Recap Returns to factors from liberalisation
• Changes in specific factor
• Changes in mobile factor

4
Recap Impact of 10 increase in PF/PC

• Change in relative prices assume 10 D in PFood
  Pcars remains constant

MRPL cars
W
W
MRPL FOOD
W
W
0food
0cars
L
5
Returns to factors

• Preliminary Conclusions
• (1) Output of Food increased, Output of cars fell
• (2) Welfare impact on mobile factor labour is
  ambiguous
• (3) Land owners gained
• (4) Impact on owners of capital used in Car
  production?

6
Returns to factors

• Owners of Capital
• D Pcar 0 but D wage gt 0
• Owners of capital (rK) are worse off
• Why?
• Under perfect competition constant returns to
  scale
• Price of a good is entirely allocated amongst the
  factors of production PC G(w, rK)
• Eg 0 D price a rise of wage (w) must be
  offset by a fall rent (rK)
• Here D W lt 10
• Therefore rK must fall
• The real return to capital in terms of both good
  falls
• (rK/ PFood) (rK/ Pcar) fall

Alternative explanation rK MPKPCar
MRPK Decline in LC raises K/L ratio, which lowers
MPK Hence rK falls
7
Returns to factors

• Conclusion
• Trade benefits the factor that is specific to
  the export sector, but hurts the factor that is
  specific to the import-competing sector. It has
  an ambiguous effect on the mobile factor.
• D rT gt D PFood gt D W gt D Pcar gt D rK

8
Change in Capital Stock

• Change in Capital stock FDI brings capital into
  the country

9
Change in Capital Stock

• Change in Capital stock FDI brings capital into
  the country

MRPL cars
W
W
MRPL FOOD
MRPL cars
W
W
W
0food
0cars
L
L
10
Returns to factors D capital

• Implications
• Output of cars increases (using capital as a
  specific factor)
• Output of food decreases as labour is drawn away
  to car industry
• Nominal wages rise in both sectors to W, which
  is an increase in REAL wages as prices remained
  constant
• Real return to specific factors fall
• Price constant but Wage rises ? share of price
  paid to specific factors (capital Land) must
  fall

11
Returns to factors D capital

• Conclusion
• With prices remaining constant, an increase in
  either specific factor reduces the return to both
  specific factors while raising returns to the
  mobile factor

12
SA Immigration Law COSATU

• The new policy is liked by unionists because of
  stringent - critics say draconian - bureaucratic
  requirements intended to protect South African
  workers from alleged job insecurity feared from
  an influx of immigrant workers.

13
Change in Mobile factor
Merely need to re-scale the horizontal access
representing Labour to account for new
immigrants. This is equivalent to a shift
rightwards of the Axis for Cars by the increase
in L. Alternatively, the Food axis can shift
leftwards

• Assume unskilled labour is mobile factor the
  country experiences immigration of unskilled
  labour. WHAT happens ?

MRPL cars
W
W
MRPL FOOD
W
W
W
W
0food
0cars
0cars
L
L
14
Returns to factors D labour

• Implications
• Output of cars and food increase (both using
  labour as an input factor)
• Nominal wages fall in both sectors to W, which
  is a decrease in REAL wages as prices remained
  constant
• Real return to specific factors rise
• Prices constant but Wage fall ? share of price
  paid to specific factors (capital Land) must
  rise

15
Returns to factors D labour

• Conclusion
• With prices remaining constant, an increase in
  the mobile factor reduces the return to the
  mobile factor while raising returns to both the
  specific factors

16
Specific factor model final conclusions

• Implications
• Tariff liberalization, foreign direct investment
  and labour migration have real welfare impacts on
  economic agents
• Policy changes with respect to these factors can
  give rise to substantial lobbying by vested
  interest groups
• Reform of an economic system becomes very
  difficult to implement if there are specific
  factors that are mobilized into lobby groups

17
Specific factor model final conclusions

• Policy proposals
• Bind liberalization programme through
  international agreements such as bilateral or
  multilateral reductions (WTO, Free trade
  agreement with EU)
• Reduce specificity of factors, i.e. training
  programmes for labour, financial assistance for
  new investment
• Create mechanism in which winners compensate
  losers