Source: Piketty Saez. Share (in %), excluding capital gains. Figure 1: The top decile income share in the U.S., % 45% 40% 35% 30% 25%

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1 The Hecksher-Ohlin-Samuelson (HOS) model Extension of Ricardian model: trade is explained by comparative advantage but those are based on:du modèle ricardien: - differences of endowments in factors of production (capital, labour ) - not on differences of technologies Allows to analyse the question of the link between inequalities and trade Important message of the HOS model - international trade generates a net gain for all countries -but inside countries, loosers and winners - original HOS model : 2 factors of production ; capital and labour Here, reinterpretation in terms of skilled and unskilled workers -Is trade with countries of the South responsible for the increase of inequalities in the North - HOS model allows to answer this question with an analytical framework so as to quantify the role of trade relatively to other «suspects» - biased technological progress (biased in favour of skilled workers) - diminished power of unions - decrease of redistribution policies (taxes, education ) and other sociological factors - immigration...

2 Inequalities: different measures - ratio of average wage depending on years of schooling : - In the US, very clear: education premium has increased between 1979 and real wage of workers (fulltime) has -decreased by 20,2% : less than 12 years of schooling decreased by 13,4%: years of schooling - increased 3,4%: 16 years or more of schooling - increased 14%: more than 18 years of study Figure 1: The top decile income share in the U.S., % Share (in %), excluding capital gains 45% 40% 35% 30% 25% Source: Authors' computations based on income tax returns (table A1, col. P90-100) Source: Piketty Saez -Large increase of inequalities in GB too since Attention difference between inequalities of income (market) and disposable income (after taxes and transfers) -In the US both increased -In UK, strong increase of (market) income but not of disposable incomes ( same in Canada)

3 - In Continental Europe less clear on income inequalities - increase in Italy - small increase in Scandinavian countries and Germany since small increase in France since 1982 but not since 1970 and decrease of disposable income inequalities (after taxes and transfers) Évolution des Inequalities inégalités en France France andet US aux États-Unis Indice de Gini (en %) Gini index % États-Unis US US Before Revenu tax avant income impôt France Disposable Revenu disponible income Graph 2 : The top decile income share in France, and % 49% 48% 47% 46% 45% 44% 43% 42% 41% 40% 39% 38% 37% 36% 35% 34% 33% 32% 31% 30% 29% 28% 27% 26% 25% Source: Author's computations based on income tax returns (see table A1, col. P for the corresponding series) Source: Piketty

4 Graph 21 : The ratio between the average wage of managers ("cadres superieurs") and the average wage of production workers ("ouvriers") in France, ,00 4,80 4,60 4,40 4,20 4,00 3,80 3,60 3,40 3,20 3,00 2,80 2,60 2,40 2,20 2, Ratio (average wage of "cadres superieurs")/ (average wage of "ouvriers") Source: Author's computations based on wage tax returns Source: Piketty - However, decrease in share of unskilled workers in total employement: - in 1982: 27% of total employement (full-time equivalent) - in 1994: 21% - in 2001: 22% Employement : has decreased a lot between 1982 and millions to 3.6 millions (full-time equivalent) then increased again to 4.3 millions in Usual explanation: decrease in the demand for unskilled workers In anglo-saxon countries: decrease in wages but no increase in unemployment Continental Europe : rigid wages and increase of unemployment Increase in inequalities in both cases : - visible in terms of wages and income (US, GB) - in terms of unemployment (France, Germany)

5 Unskilled workers wage supply W U US Demand W U L U Europe L U Unskilled labour - Increase in North-South trade (with low wage countries): France: in 1971 trade with developing countries (except oil exporters) represented 2% of GNP in 1994: 2.6 % of GNP But remains relatively small still : among the 20 most important trade partners of France only two low wage countries (China: 7th rank, importations, 4 times less imports than from Germany and Turkey 16th) - Very large drop of imports from Africa (except OPEC): 29% of total imports in 1969; 8% in 1995 Figure 2.5: Regions' share in world manufactured exports 100% 80% 60% 40% Rest World Other Asia Japan China N.America Rest W.Eu UK 20% 0%

6 What link between the increase of exports of low wage countries (New Industrialized countries from Asia and less so from Latin America) and the increase in inequalities in the North? HOS model helps to explain why : -Opening of trade between countries relatively abundant in skilled workers (North) and countries relatively abundant in unskilled workers (South) generates an increase in inequalities between skilled and unskilled in the North -Two questions: 1) What is the theoretical mechanism? 2) Is this mechanism important quantitatively? Version of HOS model with two factors of production : Skilled workers : L S Unskilled workers: L U increase in wage inequalities: W S / W U Traditional version (Krugman and Obstfeld): capital (K) et Labour (L) Same type of reasoning on r (rate of return on capital) and W (wage) Inequalities: very large increase (in US) of the education and skill premium ratio : W S / W U has increased a lot For an economist: Very clear that should be linked to movements in relative demand and supply of skilled and unskilled BUT we know that relative skilled labour has increased since the beginning of the 1980s SO, there must have been a very very large increase in the relative demand for skilled (relative to unskilled)

7 W S / W U relative supply of skilled (short-term) Relative demand for skilled L S / L U Assumptions: 2 x 2 x 2-2 factors of production : skilled/unskilled - 2 sectors: aeronautics and textile - 2 countries : Home and Foreign The two sectors use the two factors of production: but each is «intensive» in a different factor textile intensive in unskilled workers Aeronautics intensive in skilled workers factors are not substitutable (see later for substitutability) coefficients of production function describe the technologies which are used : Same technologies in both countries (different assumption from Ricardo) a UT : number of units of L U per unit of textile a ST : number of units of L S per unit of textile a UA : number of units of L Y per unit of aeronautics a SA : number of units of L S per unit of aeronautics

8 Aeronautics production is intensive in skilled workers production (L S ) production of textile intensive unskilled workers (L U ) a UT / a ST > a UA / a SA Relatively, it takes more hours of unskilled labour than skilled labour in textile than in aeronautics The only difference between the 2 countries: their relative endowment in skilled and unskilled workers L U et L S in North L* U et L* S in South L S / L U > L* S / L* U Attention! It is the relative abundance that matters Luxemburg is relatively abundant in skilled workers with respect to China (not in absolute terms) Production possibilities: Constraint on unskilled: a UT Y T + a UA Y A L U Constraint in skilled: a ST Y T + a SA Y A L QS or Y A L U / a UA -(a UT / a UA ) Y T Y A L S / a SA -(a ST / a SA ) Y T The two constraints must be verified

9 Y A L U /a UA Unskilled Slope: - a UT /a UA a UT / a ST > a UA / a SA ou a UT / a UA > a ST / a SA L S /a SA A Skilled Slope: - a ST /a SA L U /a UT L S /a ST Y T If all workers are employed (full employment) then production is done at point A «Anglo-Saxon» version of the model No unemployment and the price of factors (skilled and unskilled wages) are flexible. If one knows what happens in this case, on can can deduce what would happen when wages are rigid as in Continental Europe What happens when the number of skilled workers increase? Y A L U /a UA Unskilled L 2S /a SA L 1S /a SA B A Skilled L U /a UT L S /a ST Y T

10 If skilled workers increase from L 1S to L 2S aeronautics production increases textile production decreases Rybczynski Theorem : An increase in the endowment of a factor of production leads to a more than proportional increase of the production of the sector that uses intensively this factor. The production of the other sector decreases. Intuition of the biased expansion: For Y A to increase, some unskilled workers must go from the textile sector to the aeronautics sector : Y T must fall Can be interpreted as a result that links the relative efficiency of a country and its endowments : A country will be relatively efficient (comparative advantage) in the sector intensive in the factor of production with which the country is relatively well endowed. If L S / L U > L* S / L* U North is relatively efficient in aeronautics South is relatively efficient in textile Attention relative and not absolute abundance determine comparative advantage Y A Y A Exemple: L U =L* U L S > L* S Unskilled (N and S) Skilled N B Y* A A Unskilled S Y T Y* T Y T

11 What is the relation between goods prices and factor prices? international trade changes goods prices and through this changes factor prices : wages W S W U W* S W* U Increase in inequalities in the North if W S /W U increases P T textile price P A aeronautics price Perfect competition on goods and factor markets: Zero profits: income = total costs P T Y T = W S a ST Y T + W U a UT Y T P A Y A = W S a SA Y A + W U a UA Y A Remark: wages are equalized across sectors because workers are mobile Textile: W S = P T / a ST - a UT / a ST W U Aeronautics : W S = P A / a SA - a UA / a SA W U Skilled wage depends (for given goods prices) negatively on unskilled wage And a UT / a ST > a UA / a SA (textile relatively intensive in unskilled) P T /a ST W Q Textile Slope: - a UT /a ST a UT / a ST > a UA / a SA P A /a SA W S Aeronautics Slope: - a UA /a SA W U P T /a UT P A /a UA W U

12 P T /a ST W S Suppose P A increases W S increases W U decreases B P A /a SA W S A W U P T /a UT P A /a UA W U Stolper-Samuelson Theorem : An increase of the relative price of a good increases the price of the factor of production intensive in the production of this good and decreases the price of the non intensive factor. Important: The effect of the price of the good increase is amplified by the existence of the 2 sectors Intuition: P A profits temporarily firms enter (or each increases its production) in sector A until profits = 0 relative demand of intensively used factor of production (skilled) wages of skilled In textile sector, firms incomes have not changed but of skilled wages unskilled wages must fall or else negative profits in textile sector (textile production falls) Both skilled and unskilled workers go from T sector to A sector

13 Effect of international trade on factor prices: through the effect on goods prices North and South identical in terms of technologies (different from Ricardo) a UT a ST a NA a SA identical in North and South Identical preferences (same relative demands as a function of relative prices) and L S / L U > L* S / L* U North relatively abundant in skilled workers South relatively abundant in unskilled workers We know (Rybcynski theorem) that for a given relative price of goods North produces relatively more A than T: comparative advantage linked to relative abundance of skilled workers South produces relatively more in T than in A: comparative advantage linked to relative abundance of unskilled workers So relative supply curves are different in autarky Relative demand curves are identical P A /P T relative supply South P* A / P* T Relative supply North P A / P T Relative quantities Y* A / Y* T Y A / Y T

14 In autarky: the price in the aeronautics sector relative to the price in the textile sector is higher in the South than in the North What happens with trade (no transport costs)?: Arbitrage implies that relative price must equalize in the world So in the North: relative price in A increases In the South it decreases P A / P T P A /P T Relative price in South (autarky) Y* A / Y* T South relative supply World relative supply Relative Supply North Y A / Y T P A / P T P A / P T Relative quantities Relative price in North autarky What happens to production and the patterns of trade? The increase in the relative price of aeronautics in the North leads to an increase of aeronautics production in the North decrease of textile production textile (technical constraint) The increase in the relative price of textile in the South leads to an increase of production of textile in the South lower production in aeronautics baisse (technical constraint)

15 Who exports what? North exports aeronautics and imports textile South exports textile and imports aeronautics Hecksher-Ohlin Theorem : countries tend to export goods whose production is intensive in factors of with which they are relatively well endowed Corollary on income distribution: owners of production factors which are relatively abundant in a country gain from international trade whereas owners of production factors which are relatively rare loose So skilled workers in the North gain from trade and unskilled workers in the North loose Conflict of interest on globalisation between skilled and unskilled In the South, unskilled gain and skilled loose L S / L U > L* S / L* U with trade P A / P T W S et W U Increase of inequalities in the North Other result from HOS model (HOS theorem) International equalisation of goods prices leads to international equalisation of factor prices Why? Remember how wages are determined (zero profits) Textile: W S = P T / a ST - a UT / a ST W U Aeronautics : W S = P A / a SA - a UA / a QA W U Same equation in North and South when in free trade

16 Attention, too extreme result: - Depends on the assumption that productivities of (un) skilled are equal in North and South (right interpretation: for a given à productivity level) - Depends on the absence transport costs, tariffs, non tradable goods etc... If no equalisation of goods prices then no equalisation of factor prices - Depends on the fact that both countries continue to produce both goods: no total specialisation. If one good disappears then no total convergence of factor prices. If endowments are extremely different then complete specialisation and no equalisation of factor prices The result of equalisation of factor prices should be interpreted rather as a tendency towards equalisation Intuition: Trade in goods is a substitute to trade in (immobile) factors Exports of textile from South to North: exports goods that «incorporate» relatively more unskilled workers than skilled Same effect than the increase of the supply of unskilled of workers in the North (Remember 20 millions Chinese peasants enter the manufacturing sector in China each year!) As in the Ricardian model, gains to trade for both countries because specialisation (partial) in the sector that is relatively more efficient Intuitively: in the North increase in the production of A and increase in its price ; Real income rises (in the South too) It is always possible in theory to redistribute (taxes, transfers, public education ) the gains from those who gain (skilled) to those who loose (unskilled) : protectionism is not the best way to redistribute

17 Opening to trade with South implies more redistribution in the North then Is this true in reality? Yes and no: - Empirical evidence that industrialized countries more open to trade (small countries) are also those where Welfare state (lots of redistribution) is more developed (Scandinavian countries) -If redistribution (taxes, transfers, etc ) creates distortions then not obvious that gains of trade remain if condition is that no one looses - Financial globalisation means redistribution is harder (taxing mobile capital) exactly at the time when it would be more necessary What happens when factors of production are substitutable? (K&O) In this case the ratio of L S and L U depends on relative wage W S / W aeronautics U textile L U / L S Sector A is intensive in S: So if W S / W U rises then P A / P T rises too P A / P T W S / W U

18 If with trade, P A / P T rises then: W S / W U rises too and both sectors will use more unskilled relative to skilled workers P A / P T W S / W U A T P A / P T L U / L S If with trade, both sectors use more unskilled workers per skilled worker then Marginal productivity of unskilled workers has increased (marginal productivity of unskilled has decreased) If factors of production are paid their marginal productivity (competitive economy) - Skilled wages must rise - Unskilled wage decrease