Lecture 6: Ricardo model: Relative wages and productivity

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Lecture 6 Ricardo model Relative wages and
productivity

• ECO 3024F

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Structure

• Wages and productivity
• Limitations of Ricardo Model
• Empirical evidence
• Readings
• Ch 1 , 2 3 of Krugman and Obstfeld
• Golub, S. 1998. Does trade with low wage
  economies hurt American workers READER?
• Edwards, L Golub, S. 2003. South Africas
  international cost competitiveness A sectoral
  analysis. READER
• Krugman. P. Ricardos difficult idea READER

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Question

• Can South Africa compete against China where
  wages are between 5 and 10 times lower?
• Will trade force down SA workers wages down to
  those of China?
• Some views
• Companies that produce goods in foreign
  countries to take advantage of cheap labor should
  not be permitted to dictate the wages paid to
  American workers
• Impose a tax or tariff on goods brought into
  this country equal to the wage difference
• Quotes cited in Golub (1998)
• What are your views on this?
• Can the Ricardo model provide any insight into
  this?

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Discussion

• Golub (1998)
• Wages are determined by absolute advantage
• Trade is determined by comparative advantage
• What is cost of product?
• Cost wageunit labour requirement
• In our example Costx Wxax
• Costy Wybx

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Relative wages productivity

• Home will produce a good if cost home lt cost
  competitor
• Home produces and exports X if
• CostHX WHaH lt WFaF CostFX
• i.e. if WH/WF lt aF/aH
• Recall 1/aH MPLXH
• aF/aH MPLXH/MPLXF
• Home exports if Relative wage lt Relative
  productivity

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South African cost competitiveness
Source Edwards and Golub (2003)
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South African cost competitiveness
Source Edwards and Golub (2003)
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Although in the simple Ricardian model, we never
directly referred to wages (only to
productivity), the relative wage relative
productivity relationship existed behind the
scenes.
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Data recap

• Unit labour per unit output
• Industry Home Foreign
• X (coffee) ah 1 af 6
• Y (cloth) bh 2 bf 3
• When 1/2 lt PX/PY lt 2
• Home specializes in X Foreign specializes in Y
• Other insights?
• Home 6 times as productive in X (MPLXH/MPLXF
  af/ah )
• Home 1.5 times as productive in Y (MPLYH/MPLYF
  bf/bh )

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Relative wages

• New world price ratio P 1
• Assume price of X R 30 price of Y
• What is the wage in each country?
• Wage MPL Price (or P/unit labour cost)
• Home WH MPLX PriceX 1R30 R30
• Foreign WF MPLY PriceY 1/3R30 R10
• Relative wage WH/WF R30/R10 3

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Lets plot relative wages relative productivity

• Relative wage is between productivity ratios
• Each country has Cost Advantage in production
• Home
• in X 6 times more efficient but only 3 times
  more expensive
• Foreign
• in Y 2/3 as productive, but pays 1/3 the wage
• Solution
• Each product gets produced where it is the
  cheapest to produce!
• Question What happens if Px rises?

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Multiple goods model
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Do the results change if we introduce Multiple
Goods?

• Unit labour requirements
• Industry Home Foreign Rel Prod
• X (coffee) ah 1 af 6 6
• Y (cloth) bh 2 bf 3 1.5
• Z (apples) 1 10 10
• W (leather) 1 1 1
• Order these by ratios of industries'
  productivities
• MPL1H/MPL1F lt MPL2H/MPL2F lt lt MPLnH/MPLnF
• And plot on the relative w and relative
  productivity scale

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Multiple Goods model
Relative wage WH/WF
Discuss the adjustment process if relative wages
are too low
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Note We can construct our multiple Goods model
as follows (see KO)
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Sub-conclusions

• The competitiveness of an industry depends not
  only on relative wages but also on relative
  productivity
• Relative wages generally follow relative
  productivity
• Export products where relative productivity gt
  relative wages
• Declining terms of trade (Pexport/Pimport)
  negatively affect relative wages

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Limitations of model

• What are the limitations of model?
• Model assumes full specialization
• What are the sources of labour productivity?
  Capital?
• Need to include other factors of production
• What about transport costs?
• Income distribution Model predicts that all
  factors gain
• Cannot explain intra-industry trade

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Schematic Transport costs
Relative wage WH/WF
With transport costs, goods at the margin no
longer become profitable to trade
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Empirical evidence

• Is there any support for the Ricardo model? i.e.
  Does it predict trade flows?
• Read
• Golub, S. 1998. Does trade with low wage
  economies hurt American workers?
• Edwards, L Golub, S. 2003. South Africas
  international cost competitiveness A sectoral
  analysis.

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Does SA cost competitiveness affect exports?
1970-79
1980-89
3.00
2.00
1.80
2.50
1.60
1.40
2.00
1.20
RULC
1.50
RULC
1.00
0.80
1.00
0.60
0.40
0.50
0.20
0.00
0.00
0
500
1000
1500
2000
2500
3000
3500
0
500
1000
1500
2000
2500
3000
3500
4000
Real exports (R million)
Real exports (R million)
1990-98
1990-98
2.00
2.00
1.80
1.80
1.60
1.60
1.40
1.40
1.20
1.20
RULC
1.00
RULC
1.00
0.80
0.80
0.60
0.60
0.40
0.40
0.20
0.20
0.00
0.00
0
1000
2000
3000
4000
5000
6000
7000
0.00
0.10
0.20
0.30
0.40
0.50
0.60
Real exports (R million)
Exports/Output
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Does SA cost competitiveness affect exports?
Source Edwards and Golub (2003)
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Conclusion

• International competitiveness
• SA competitive, as measured by RULC, in most
  sectors vis-à-vis developed countries, but not
  developing countries
• SA competitiveness improved during the 1990s
• but improvement substantially reflects the large
  depreciation of the rand against other currencies
• No clear pattern of competitiveness at the
  sectoral level over time
• Effect of competitiveness on exports
• South African exports respond strongly to labor
  cost competitiveness (relative wages and relative
  productivity) (particularly L-intensive)
• Growth in exports during the 1990s in large
  measure due to improved relative unit labor costs