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TOPICS ON GLOBALIZATION (code 910012-ENG) Economies of Scale, Imperfect Competition, and International Trade Academic Year 2018/2019 Anna M. FALZONI
TOPICS ON GLOBALIZATION
(code 910012-ENG)
Economies of Scale, Imperfect Competition, and
International Trade
Academic Year 2018/2019 Anna M. FALZONI
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Shape of the global trade network
International merchandise trade flows are to a large extent transcontinental. In 2016, some of the largest flows ran between China, the United States of America, and
Germany, jointly accounting for US$990 billion, 6 per cent of world imports. Considerable trade was recorded also between the United States of America and its neighbours,
Canada and Mexico, as well as between mainland China and surrounding economies, including the Republic of Korea, Japan, Taiwan Province of China and Hong Kong
Special Administrative Region of China (Hong Kong SAR). In some regions, economies have developed stronger ties for mutual exchange of goods than in others. In 2016,
in Europe more than two thirds and in Asia more than half of all exports were delivered to trading partners in the same region. In Oceania, Latin America and the Caribbean
and in Africa this was the case for less than one fifth. Source: UNCTAD, 2018
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Source:
UNCTAD, 2018
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Types of Economies of Scale
• External economies of scale may result if a larger industry allows for more efficient provision of services or equipment to firms in the industry.
– Many small firms that are competitive may comprise a large industry and benefit when services or equipment can be efficiently provided to all firms in the industry.
• Internal economies of scale result when large firms have a cost advantage over small firms, causing the industry to become
uncompetitive.
Internal Economies of Scale
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Internal Economies of Scale
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b. Demand
Consumers benefit from increased variety
Q = S[1/n – b(P – Pavg)]
– Q is an individual firm’s sales
– S is the total sales of the industry
– n is the number of firms in the industry
– b is a constant term representing the responsiveness of a firm’s
sales to its price
– P is the price charged by the firm itself
– Pavg is the average price charged by its competitors
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• To make the model easier to understand, we assume that all firms
face the same demand functions and have the same cost functions:
– Thus in equilibrium, all firms should charge the same price:
P = Pavg
• In equilibrium
– Q = S/n + 0
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AC = F/Q + c (1)
Q
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Hypothetical example of gains from trade
in an industry with monopolistic competition
Domestic
market before
trade
Foreign
market
before trade
Integrated
market after
trade
Industry sales
Number of
firms
Sales per firm
Average cost
Price
900,000
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150,000
10,000
10,000
1,600,000
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200,000
8,750
8,750
2,500,000
10
250,000
8,000
8,000
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Inter-industry and Intra-industry Trade
1. Gains from inter-industry trade reflect comparative advantage.
2. Gains from intra-industry trade reflect economies of scale (lower costs) and wider consumer choices.
3. The monopolistic competition model does not predict in which country firms locate, but a comparative advantage in producing the differentiated good will likely cause a country to export more of that good than it imports.
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Inter-industry and
Intra-industry Trade
4. The relative importance of intra-industry trade depends on how
similar countries are.
– Countries with similar relative amounts of factors of production
are predicted to have intra-industry trade.
– Countries with different relative amounts of factors of
production are predicted to have inter-industry trade.
5. Unlike inter-industry trade in the Heckscher-Ohlin model, income
distribution effects are not predicted to occur with intra-industry
trade.
Empirical Applications of
Monopolistic Competition and Trade
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Empirical Applications of Monopolistic
Competition and Trade*
• The idea that free trade expands the range of products available to customers is not new—Ricardo even mentions it.
• The ability to model the effects of trade under a monopolistically competitive model is new.
– Developed by Helpman, Krugman, and Lancaster.
• The research was used to shed light on free trade agreements, which guarantee free trade among a group of countries.
• The potential for Canadian firms to expand output was a key factor in Canada’s free-trade agreement with the U.S. in 1989 and entry into NAFTA (along with Mexico) in 1994.
• NAFTA is a good example to illustrate gains and costs predicted by the monopolistic competition model.
* The following slides are based on the book by Feenstra and Taylor (2008).36
What Happened When Two Countries Liberalized Trade?
• Gains and Adjustment Costs for Canada
• Data from 1988–1996 was used by Daniel Trefler of University of Toronto to estimate effects of the Canada-U.S. Free Trade Agreement.
• Some findings:– Short-run adjustment costs of 100,000 jobs, or 5% of
manufacturing employment.– Some industries that had very large tariff cuts saw employment
fall by as much as 12%– Over time, however, these job losses were more than made up
for by creation of new jobs elsewhere in manufacturing.– There were no long run job losses due to NAFTA.
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What Happened When Two Countries Liberalized Trade?
• In the long run, large positive effects on productivity were found.
– 15% over eight years in industries most affected by tariff cuts—
compound growth of 1.9%/year.
– 6% for manufacturing overall—compound growth of 0.7%/year.
– There was also a rise of 3% in real earnings over this period.
• These findings support the monopolistic competition model.
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Empirical Applications of Monopolistic
Competition and Trade
• Gains and Adjustment Costs for Mexico
– Mexican President Miguel de la Madrid felt that the economic
reforms were needed to boost growth and incomes in Mexico.
– Joining NAFTA was a way to ensure the permanence of the
reforms already underway.
– Under NAFTA, Mexican tariffs on U.S. goods declined from an
average of 14% in 1990 to 1% in 2001.
– In addition, U.S. tariffs on Mexican imports fell as well.
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Empirical Applications of Monopolistic
Competition and Trade
• Productivity in Mexico
– Panel A in figure 6.8 shows the productivity over time for two
types of manufacturing firms:
• Maquiladora plants—close to the border and produce almost
exclusively for export to the U.S.
• Non-Maquiladora plants
– Maquiladora plants should be most affected by NAFTA
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Empirical Applications of Monopolistic
Competition and TradeFigure 6.8
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Figure 6.8 (a) Labor Productivity and Wages in Mexico Panel (a) shows labor productivity for workers in the
maquiladora Mexican manufacturing plants and for workers in non-maquiladora plants in the rest of Mexico.
Empirical Applications of Monopolistic
Competition and Trade
• Productivity in Mexico
– For the maquiladora plants, productivity rose 45% from 1994 to
2003—compound growth rate of 4.1%/year.
– For non-maquiladora plants, productivity rose overall by 25%—
compound growth rate of 2.5%/year.
– The difference, 1.6%/year, is an estimate of the impact of
NAFTA on the productivity of maquiladora plants over and above
the increase in productivity that occurred in the rest of Mexico.
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Empirical Applications of Monopolistic
Competition and Trade
• Adjustment Costs in Mexico
– When Mexico joined NAFTA, it was expected that the agricultural sector would fare the worst due to competition from the U.S.
• Tariff reductions in agriculture were phased in over 15 years.
– The evidence to date shows the corn farmers did not suffer as much as was feared. Why?
• The poorest farmers consume the corn they grow, rather than sell it.
• Mexican government was able to use subsidies to offset the reduction in income for other corn farmers.
– Total production of corn in Mexico rose following NAFTA.
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Empirical Applications of Monopolistic
Competition and Trade
• Adjustment Costs in Mexico
– For maquiladora plants, employment grew rapidly following
NAFTA to a peak of 1.29 million in 2000.
– After that, this sector entered a downturn.
• The U.S. entered a recession decreasing demand for
Mexican exports.
• China was competing for U.S. sales by exporting goods
similar to those sold by Mexico.
• The Mexican peso became over-valued, making it difficult to
export abroad.
– Employment in the maquiladora sector fell after 2000 to 1.1
million in 2003.
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Empirical Applications of Monopolistic
Competition and Trade
• Adjustment Costs in Mexico
– The maquiladora sector faces increasing international
competition (not all due to
NAFTA).
– This can be expected to raise the volatility of its output and
employment.
– The volatility can be counted as a cost of international trade for
workers who are displaced.
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Empirical Applications of Monopolistic
Competition and Trade
• Gains and Adjustment Costs for the United States
– Studies on the effects of NAFTA on the U.S. have not estimated
its effects on the productivity of U.S. firms.
• It would be hard to identify the impact since Mexico and
Canada are only two of many trading partners.
– Instead, researchers have estimated the second source of gains
from trade: the expansion of import varieties available to
consumers.
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Empirical Applications of Monopolistic
Competition and Trade
• Expansion of Variety to the U.S.
– The increase in the variety of products imported to the U.S.
under NAFTA is a source of gains to U.S. consumers.
– According to one estimate, the total number of product varieties
imported into the U.S. from 1972–2001 has increased four times.
– That expansion in import variety has had the same effect as a
reduction in import prices of 1.2% per year.
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Empirical Applications of Monopolistic
Competition and Trade
• Adjustment Costs in the U.S.
– These come as firms exit the market due to import competition
and the workers employed there are temporarily unemployed.
– One way to measure this loss is to look at claims under the U.S.
Trade Adjustment Assistance (TAA) provisions.
• Offers assistance to workers in manufacturing who lose their
jobs due to import competition.
– From 1994–2002, about 525,000 workers, or about 58,000 per
year, lost their jobs and were certified as adversely affected by
trade under the NAFTA-TAA program.
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Empirical Applications of Monopolistic
Competition and Trade
• Summary of NAFTA
– The studies have been able to measure in part the long-run gains and short-run costs from NAFTA for Canada, Mexico, and the U.S.
– The monopolistic competition model indicates two sources of gains from trade.
• the rise in productivity due to expanded output by surviving firms.
– Leads to lower prices
– More varieties of products for consumers
– For Mexico and Canada, long-run gains were measured by the improvement in productivity for exporters as compared to other manufacturing firms.
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Empirical Applications of Monopolistic
Competition and Trade
• Summary of NAFTA
– For the U.S., the studies measured the long-run gains using the
expansion of varieties from Mexico, and the equivalent drop in
price faced by U.S. consumers.
– It is clear that for Canada and the U.S., the long-run gains
considerably exceed the short-run costs.
– In Mexico the gains have not been reflected in the growth of real
wages for production workers.
– The real earnings for higher-income workers in the maquiladora
sector have risen and have been the principal beneficiaries of
NAFTA so far.
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