TECHNOLOGY, GEOGRAPHY, AND

TRADEBY JONATHAN EATON AND SAMUEL

KORTUMECONOMETRICA, 2002

Elisa Katharina Orthofer February 4th, 2016

IntroductionLiterature ReviewStylized FactsMotivationThe Model/Methodology and DataCounterfactualsConclusion

OUTLINE

Ricardian Model of Comparative Advantage – early 19th century

H-O Model (Factor Proportions) – 1920s Dornbusch, Fischer, & Samuelson (1977):

“Comparative Advantage, Trade and Payments in a Ricardian Model with a Continuum of Goods”

Eaton & Kortum (2002): “Technology, Geography, and Trade”

LITERATURE REVIEW

Assumptions:

2 countries, 2 final goodsLabor as sole input in productionTechnologies differ between 2 countriesPerfect competitionNo transaction costs

THE RICARDIAN MODEL

Absolute vs. Comparative advantage (CA)CA: Country exports good in which it has the

lower relative OCCA may create gains from tradeRicardian Model not used for analysis of trade

flows anymore since it ignores crucial aspects such as Multiple countries and goods Trade in intermediates Geographic barriers

THE RICARDIAN MODEL

Concerning geography:Trade diminishes dramatically with distancePrices vary across locations

Concerning technology:Factor rewards far from equal across

countriesCountries’ relative productivities vary

significantly across industries

STYLIZED FACTS

First pair suggest geography mattersLast pair suggest technologies differEaton-Kortum (E-K) propose Ricardian model

(based on differences in technologies) with geographic barriers to capture all four facts

Model captures tension between comparative advantage and geographic barriers

MOTIVATION

Two-country D-F-S-model with continuum of goods extended to model with many countries

E-K use a probabilistic formulation of productivity differences

Show how model links bilateral trade flows to geography and prices

Trade data in manufacturers among 19 OECD countries in 1990

Finally perform counterfactual exercises

METHODOLOGY AND DATA

Differential access to technologyEfficiency varies across commodities and

countriesCost of bundle on inputs the same across

commodities within a countryConstant returns to scalePresence of geographic barriers (natural and

artificial)Perfect competition

ASSUMPTIONS OF THE MODEL

Continuum of goods z i (j)… country i’s efficiency in producing good

jc i/z i (j)… cost of producing unit of good j in

country i

Geographic barriers: iceberg cost assumption by which delivering a unit from country i to n requires producing dni units in i

Positive geographic barriers: dni > 1 for n≠iTriangle inequality: dni ≤ dnk dki

THE MODEL

Delivering unit of good j produced in i to country n:

Perfect competition implies: N…# of

countriesBuyers purchase individual goods in amounts

Q(j) to maximize utility

THE MODEL

E-K assume that country i’s efficiency in producing j is the realization of a random variable Z drawn independently for each j (remember: z i (j)…efficiency)

cost of purchasing particular good from country i in country n is the realization of random variable Pni = c idni/Z i

πni… probability that i’s price for some good the lowest

Efficiency distribution: Fi (z) = Pr[Z ≤ z]

TECHNOLOGY

T i…state of technologyReflects countries’ absolute advantageBigger T implies that high efficiency draw for

any good j more likely

Θ…technology heterogeneityLower Θ implies more variability, so more

heterogeneity: comparative advantage exerts stronger force over geographic barriers

TECHNOLOGY

Ф…price parameter that summarizes howStates of technology Input costsGeographic barriers

determine prices in each countryTwo extremes:

Zero-gravity (dni = 1 for all n and i), ф same everywhere

Autarky (dni ∞)

PRICES

Xni/Xn…fraction of n’s expenditure on goods from country i

Importer’s total purchases Xni

Exporter’s total sales Q i

TRADE FLOWS AND GRAVITY

Model implies connection between trade flows and prices differences

Country i’s share in country n relative to i’s share at home (normalized import share):

As comparative advantage weakens, normalized import shares become more elastic

Measured with data on bilateral trade in manufactures (342 observations)

TRADE, GEOGRAPHY, AND PRICES

TRADE AND GEOGRAPHY

TRADE AND PRICES

3 equations that represent full general equilibrium:

1. Price level

2. Trade shares

EQUILIBRIUM

3. Wages

L i…number of manufacturing workers in iα…fraction spent on manufacturersβ…constant labor-inputs ratio/labor share in

costs

EQUILIBRIUM

Gains from trade in manufacturers: small countries gain more

How technology and geography determine patterns of specialization: smaller countries benefit

Role of trade in spreading benefits of new technology: distance is crucial

Consequences of tariff reductions

COUNTERFACTUALS

E-K raise geographic barriers first to autarky, then to zero-gravity level

Costs of moving to autarky < gains of zero-gravity

Manufacturing employment shrinks in the four natural manufacturers (GER, JP, SE, UK), indicating comparative advantage in manufactures

Smaller countries gain more

GAINS FROM TRADE

In the case of mobile labor, geography is irrelevant for determining labor force in manufacturing

Two basic patterns: As geographic barriers start falling,

manufacturing ↘ for smaller countries and ↗ for larger countries (cheaper inputs)

As barriers keep falling, pattern reverses and forces of technology take over

Example: Denmark and Germany

TECHNOLOGY VS. GEOGRAPHY

TECHNOLOGY VS. GEOGRAPHY

Effects on welfare following increase of technology by 20 % (US, GER)

Other countries always gain through lower prices

Overall welfare effect generally lower when countries can’t downsize manufacturing labor force

The closer a country is to the source of advance, the higher its benefit

BENEFITS OF FOREIGN TECHNOLOGY

BENEFITS OF FOREIGN TECHNOLOGY

Austr

alia

Austr

ia

Belgiu

mCa

nada

Denmark

Finlan

dFra

nce

German

yGree

ce Italy

Japan

Netherl

ands

New ze

aland

Norway

Portug

alSpa

in

Swede

n UK US

-30

-10

10

30

50

70

90

110

Effects of Improved US Technologymobile laborimmobile labor

Wel

fare

Welfare rises almost everywhere with collective removal of tariffs

If US remove tariffs unilaterally, everyone benefits except the US

Eliminating tariffs within 1990 EC: gains and losses mainly depend on labor mobility

Labor immobility: main losers are nonmembersLabor mobility: main losers Northern EC

members

ELIMINATING TARIFFS

ELIMINATING TARIFFS

Austral

iaAust

ria

Belgium

Canad

a

Denmark

Finlan

dFra

nce

German

y

Greece Ita

lyJap

an

Netherl

ands

New ze

aland

Norway

Portu

gal

Spain

Swed

en UK US

-1.00

-0.80

-0.60

-0.40

-0.20

0.00

0.20

0.40

0.60Effects of Removing all Tariffs on Intra-EC trade

mobile labor

immobile labor

Aggr

egat

e W

elfa

re

Comparative advantage creates potential gains from trade

Extent of gains limited by geographic barriersTrade allows country to benefit from foreign

technological advances Country must be near the source of advance Possibility of reallocating its labor outside

manufacturing

CONCLUSION