Reference no: EM1374959

During the debate over NAFTA, opponents argue that given the relative size of the two economies, the income gains resulting from the agreement would be smaller for the US than for Mexico. Please comment on this argument in view of what you have learned about the distribution of the benefits of trade in the Classical Model.

In the Classical Model, the approach would be that there would be comparative advantage for Mexico in many different aspects. An example of this would be with the cost of labor being so low in Mexico as compared to the US, there would be an inherent advantage for anything requiring human production hours (cost per hour for labor being much less than the US). However, neo-Classical theories are very different in that the greater the difference in autarky prices, the greater the incentive to trade. In this view, Mexico's low labor rate would be viewed as a benefit to both US and Mexico as what is imported will have a greater gain than the same item produced in the US. Therefore, the US would be inclined to import more of the good from Mexico (a positive for the US) as well as the export from Mexico to the US being increased (benefit to Mexico).

Comparative advantage theories from the Classical model would be able to support the theory for the opposition, but with all factors considered, there is a positive benefit to both countries to engage in trade.

Even though the relative abundance differs widely between India and the US, countries export similar agricultural products, such as rice. What might explain this apparent contradiction in the Heckscher-Olin model?

My response:
A recent study comparing 34 countries from 165-1992 showed that even with relative factor endowments help to explain personal income distribution, the more open a country is to trade will influence the end result. By reducing trade barriers, there will be a reduction in income inequality in capital abundant countries and an increase income inequality in skill-abundant countries. To that end, trade can influence income distribution but in a much more complicated mechanism that the H-O model identifies.

Consumption changes will also play a role in this theory. By restricting imports on certain goods, creating higher domestic prices. The effects typically will be seen as income tax surcharges with the effects felt the most on the low end of the scale with the surcharge effects reducing as income increases. Increasing the imports of such products will lessen this tac surcharge burden.

Briefly discuss the alternative theories to the Heckscher-Olin theorem and indicate which of the assumption(s), if any that is/are relaxed in each alternative theory.

My response:
The imitation lag theory (Michael Posner) relaxes the H-O theory that same technology is available quickly. In the imitation lag theory, the factors of technology not be available everywhere, and that to transfer has delays associated with it, adds a new dimension. Imitation demand - demand lag = net lag and this entire principle relaxes the H-O theorem.
Another theory, the Product Cycle theory (Raymond Vernon) also relaxes a principle in the H-O model. An example of this theory would be if the US were manufacturing something new, labor is considered scarce. Therefore, achieving labor savings through technology and/or automation is an advantage. In the new product stage moves to the mature product stage where constants have been established in a process or manufacture, and automation applied relaxes the H-O theory of a constant return. There are factors which effect constant returns, including producing abroad. In the Vernon model, the ability to manage production costs through management of location, materials, etc. is in direct contrast to the H-O model of production being immobile internationally.
The Linder theory which is demand oriented, is also an added dimension to the H-O model of everything being supply focused through endowments and intensities. Linder's model show that a product can be both imported and exported which challenges the H-O theory that a comparative advantage and disadvantage cannot exist in the same good.
Finally, the Krugman theory on economies of scale and monopolistic competition are part of trade and available to all is a challenge to the H-O model of scarce factor of production.