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Chapter 4
Specific Factors and Income Distribution
◼ Chapter Organization
The Specific Factors Model
Box: What Is a Specific Factor?
Assumptions of the Model
Production Possibilities
Prices, Wages, and Labor Allocation
Relative Prices and the Distribution of Income
International Trade in the Specific Factors Model
Income Distribution and the Gains from Trade
The Political Economy of Trade: A Preliminary View
Income Distribution and Trade Politics
Case Study: Trade and Unemployment
International Labor Mobility
Case Study: Wage Convergence in the Age of Mass Migration
Case Study: Immigration and the U.S. Economy
Summary
APPENDIX TO CHAPTER 4: Further Details on Specific Factors
Marginal and Total Product
Relative Prices and the Distribution of Income
◼ Chapter Overview
In Chapter 3, the Ricardian model of trade was introduced with labor as the single factor of production
exhibiting constant returns to scale. Although informative, this model fails to highlight the observed
opposition to free trade. In this chapter, the Specific Factors model is presented to gain a better
understanding of the distributional effects of trade. After trade, the exporting industry expands, while the
import competing industry shrinks. As a result, the factor specific to the exporting industry gains from
trade, while the factor specific to the import competing industry loses from trade. However, the aggregate
gains from trade are greater than the losses.
The Specific Factors model assumes that there is one factor that is mobile between sectors (commonly
thought of as labor) and production factors that are specific to each sector. The chapter begins with a simple
economy producing two goods: cloth and food. Cloth is produced using labor and its specific factor, capital.
14 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Tenth Edition
Food is produced using labor and its specific factor, land. Given that capital and labor are specific to their
respective industries, the mix of goods produced by a country is determined by share of labor employed in
each industry. The key difference between the Ricardian model and the Specific Factors model is that in the
latter, there are diminishing returns to labor. For example, production of food will increase as labor is added,
but given a fixed amount of land, each additional worker will add less and less to food production.
As we assume that labor is perfectly mobile between industries, the wage rate must be identical between
industries. With competitive labor markets, the wage must be equal to the price of each good times the
marginal product of labor in that sector. We can use the common wage rate to show that the economy will
produce a mix of goods such that the relative price of one good in terms of the other is equal to the relative
cost of that good in terms of the other. Thus, an increase in the relative price of one good will cause the
economy to shift its production toward that good.
With international trade, the country will export the good whose relative price is below the world relative
price. The world relative price may differ from the domestic price before trade for two reasons. First, as in
the Ricardian model, countries differ in their production technologies. Second, countries differ in terms of
their endowments of the factors specific to each industry. After trade, the domestic relative price will equal
the world relative price. As a result, the relative price in the exporting sector will rise, and the relative
price in the import competing sector will fall. This will lead to an expansion in the export sector and a
contraction of the import competing sector.
Suppose that after trade, the relative price of cloth increases by 10 percent. As a result, the country will
increase production of cloth. This will lead to a less than 10 percent increase in the wage rate because
some workers will move from the food to the cloth industry. The real wage paid to workers in terms of
cloth (w/PC) will fall, while the real wage paid in terms of food (w/PF) will rise. The net welfare effect for
labor is ambiguous and depends on relative preferences for cloth and food. Owners of capital will
unambiguously gain because they pay their workers a lower real wage, while owners of land will
unambiguously lose as they now face higher costs. Thus, trade benefits the factor specific to the exporting
sector, hurts the factor specific to the import competing sector, and has ambiguous effects on the mobile
factor. Despite these asymmetric effects of trade, the overall effect of trade is a net gain. Stated differently, it
is theoretically possible to redistribute the gains from trade to those who were hurt by trade and make
everyone better off than they were before trade.
Given these positive net welfare effects, why is there such opposition to free trade? To answer this question,
the chapter looks at the political economy of protectionism. The basic intuition is that the though the total
gains exceed the losses from trade, the losses from trade tend to be concentrated, while the gains are diffused.
Import tariffs on sugar in the United States are used to illustrate this dynamic. It is estimated that sugar tariffs
cost the average person $7 per year. Added up across all people, this is a very large loss from protectionism,
but the individual losses are not large enough to induce people to lobby for an end to these tariffs. However,
the gains from protectionism are concentrated among a small number of sugar producers, who are able to
effectively coordinate and lobby for continued protection. When the losses from trade are concentrated
among politically influential groups, import tariffs are likely to be seen. Ohio, a key swing state in U.S.
presidential elections and a major producer of both steel and tires, is used as an example to illustrate this
point with both Presidents Bush and Obama supporting tariffs on steel and tires, respectively.
Although the losers from trade are often able to successfully lobby for protectionism, the chapter
highlights three reasons why this is an inefficient method of limiting the losses from trade. First, the actual
impact of trade on unemployment is fairly low, with estimates of only 2.5 percent of unemployment
directly attributable to international trade. Second, the losses from trade are driven by one industry
expanding at the expense of another. This phenomenon is not specific to international trade and is also
seen with changing preferences or new technology. Why should policy be singled out to protect people
hurt by trade and not for those hurt by these other trends? Finally, it is more efficient to help those hurt by
Chapter 4 Specific Factors and Income Distribution 15
trade—by redistributing the gains from trade in the form of safety nets for those temporarily unemployed
and worker retraining programs to ease the transition from import competing to export sectors—than it is
to limit trade to protect existing jobs.
Finally, the chapter uses the framework of the Specific Factors model to analyze the distributional effects
of international labor migration. With free migration of labor across borders, wages must equalize among
countries. Workers will migrate from low-wage countries to high-wage countries. As a result, wages in the
low-wage countries will rise, and those in the high-wage countries will fall. Though the net effect of free
migration is positive, there will be both winners and losers from migration. Workers who stayed behind in
the low-wage country will benefit, as will owners of capital in the high-wage country. Workers in the
high-wage country will be hurt, as will owners of capital in the low-wage country. We also need to
consider the education levels of migrants relative to the country they move to. Immigrants to the United
States, for example, tend to be concentrated in the lowest educational groups. Thus, migration is likely to
only have negative effects on the wages of the least educated Americans while raising the wages of those
with more education.
◼ Answers to Textbook Problems
1. Texas and Louisiana are both oil-producing states. A decrease in the price of oil will reduce output in
these two states, hurting owners of capital and workers in the oil industry. Although some capital will
16 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Tenth Edition
b.
3. a. Draw the marginal product of labor times the price for each sector given that the total labor
Chapter 4 Specific Factors and Income Distribution 17
b. From part (a), we know that 30 units of labor are employed in Sector 1 and 70 units of labor are
employed in Sector 2. Looking at the table in Question 2, we see that these labor allocations will
produce 48.6 units of good 1 and 86.7 units of good 2.
d. The decrease in the relative price of good 2 led to an increase in production of good 1 and a
