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Specific Factors Model
Policy Discussion
Trade, technology, and job losses in U.S. manufacturing
ECON-371
International Economics: Trade
Fall 2022
Portions © 2021 by Worth Publishers
International Economics, 5th edition, Feenstra/Taylor, used with
permission. Other portions from the professor or other sources.
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(SFM)
• An increase in the relative price of an industry’s
output will increase the real rental earned by the
factor specific to that industry but will decrease the
real rental of the factors specific to the other
industry.
• Since the relative price of exports rises when a
country “opens” to trade, we can conclude:
– The specific factor used in export industries generally
gains (owners of capital in our example)
– The specific factor used in import-competing industries
generally loses (owners of land in our example)
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Summary on the SFM
• The earnings of specific factors change the most from relative
price changes due to international trade.
• This is because these factors (land and capital) cannot move
between industries.
• The earnings changes are in opposite directions and so the
interests of T and K are opposed to each other.
• Changes in wages paid to labor (mobile factor) are less
extreme and depend on the workers’ consumption pattern.
• Remember, our assumptions (L mobile, K and T immobile) are
only examples; other cases can be analyzed
– For example, K is mobile and there are two kinds of labor, more
and less skilled/educated, which are immobile.
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Conclusions
• In the Ricardian model, we found that trade could never make a
country (as a whole) worse off.
• That remains true in the Specific Factors Model, but owners of
some factors of production can lose from trade.
– The factor specific to the importing industry suffers a fall in its real
returns.
– The factor specific to the exporting industry enjoys an increase in
its real returns.
• If labor is mobile, it does not experience these extreme changes
in wages: real wages rise in terms of the imported good, but fall
in terms of the export product.
• Hence, gains or losses to the mobile factor (labor in our
example) depend on what the factor owners consume.
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Discussion: HO vs SFM
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• In the HO model, factor abundance determines trade patters and, as
a result, winners and losers.
• Owners of the abundant factor are better off while owners of the
scarce factor are worse off.
• In the SFM model, winners and losers are determined by factor
specificity.
• The owners of the specific factor to the exporting industry are better
off while owners of the specific factor to the importing industry are
worse off.
• The current trend in rising inequality in the US may lend itself better to
a K/L split. This means that the HO model is better suited.
• Nevertheless, the SFM introduces rigidities which could explain the
rising skill premium (if we assume that high-skilled labor and low-
skilled labor are the specific factors).
• As mentioned before, models have strengths and weaknesses.
• While each model cannot provide the whole picture, but they can help
us solve key pieces of the puzzle.
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Theory versus Reality
• Most trade models assume full employment
– For example, the specific factors model (SFM) assumes
• Why do trade economists usually ignore unemployment?
– Unemployment is usually considered a macro phenomenon
• Many people laid off due to trade do find new jobs eventually
• But finding another job is not always so easy
– Not in a recession, like 2008-9 (really until about 2012) and today
– Not for workers whose skills don’t match those of the expanding
export industries, or who live in depressed communities/localities
– Even those who eventually find a new job may get lower wage,
– “Structural” unemployment is exacerbated by geographical
immobility and lack of education or retraining
• Therefore, we should not ignore (un)employment effects of
trade!
LLL AM =+
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Impact of trade “shocks” on U.S. labor markets
• NAFTA tariff reductions caused significant
reductions in U.S. wages
– Especially for less-educated workers in local areas
most impacted by the tariff cuts (Hakobyan and
McLaren, 2016)
• Including local workers in other sectors such as services
• Trefler (2004) found a 15% loss of jobs in Canadian
manufacturing industries as a result of earlier (1989) US-
Canada FTA tariff cuts
• The “China Shock”
– Impact of the rise of China in the global economy,
especially after it joined the WTO (World Trade
Organization) in 2001
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Decrease in the Price of Manufactured
Goods in the SFM
With a decrease in the
price of manufactured
goods, the curve PM •
MPLM shifts down to
P'M • MPLM and the
equilibrium shifts from
point A to point B. The
amount of labor in
manufacturing falls to
0ML' and the amount
of labor in the service
sector rises to 0SL'.
The wage falls to W'.
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Manufacturing vs. total output
Source: Fort et al. (2018). 10
© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Most job losses (from 17.8 to 11.1 million) have occurred
through plant shutdowns (“deaths”) within firms.
Source: Fort et al. (2018)
https://www.nber.org/system/files/worki g_papers/w24490/w24490.pdf
While some
firms go out of
business, they
primarily shut
down plants,
which explains
almost 2 thirds
of the loss in
manufacturing
employment.
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Debate: the causes of manufacturing job
losses in the U.S. economy
• The context: we focus on manufacturing because
– it produces about 80% of traded goods and is the main source of
technological innovation
– historically, manufacturing jobs generally paid higher wages (no
longer true today)
– there has been a sharp decline in manufacturing jobs since 2000
(over 5 million jobs lost)
• But is this caused by international trade, technological
change, or a combination of both?
– Houseman (2018) and Fort et al. (2018) argue that this is a false
dichotomy
• we cannot determine the exact proportions due to trade vs.
technology
• Trade and technology can’t be separated, since each one
influences the other!
– Clearly, both are important factors, but they interact
• So you should be suspicious of estimates that attribute X% of the
decline to one or the other!
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Proportional
changes in
value added
(output),
employment,
and imports
by industry,
1977 to 2000
Source: Fort et al. (2018).
Only a few sectors had
big job losses associated
with rising imports then,
but they were important
sectors!
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Proportional
changes in
value added
(output),
employment,
and imports
by industry,
2000 to 2007
In this period, big
decreases in jobs were
correlated with large
increases in imports in
most sectors.
Note: rising value added in computers is
misleading according to Houseman (2018).
Source: Fort et al. (2018). 14
© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
APPLICATION: The “China Shock” and
Employment in the United States
• In the specific-factors model we assumed that workers leaving one
industry could be absorbed freely into the other.
• After China joined the WTO in 2001, U.S. imports from China grew
rapidly, from 10% of total imports in 2001 to 23% in 2009.
• The large increase in the share of U.S. imports coming from China
and its impact on employment in manufacturing are called the
“China shock.”
• Studies have found that 2 million jobs or more were lost in U.S.
manufacturing industries.
• In reality, we see that with a very large change in prices (as
occurred with the “China shock”), it takes more than one decade for
enough jobs to be created in export industries to balance the losses
in import industries.
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Job Gains and Job Losses in U.S.
Manufacturing Industries
For the period 1991–1999, estimated job gains due to rising U.S. exports are
shown in green, and the estimated job losses due to rising U.S. imports are
shown in orange. For the period 1999–2011, estimated job gains due to rising
U.S. exports are shown in blue, and the estimated job losses due to rising U.S.
imports are shown in red.
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Real wages have stagnated or fallen in US
manufacturing, but have increased in services since
the late 1990s
Real Hourly
Earnings of
Production
Workers*
(*excluding managers,
supervisors, executives,
etc.)
This chart shows the real wages (in constant 2018 dollars) earned by production workers* in U.S.
manufacturing, in all private services, and in information services (a subset of all private services).
Services includes wholesale and retail trade, finance, law, education, information technology, software
engineering, consulting, and medical and government services.
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© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Manufacturing firms are shifting their employment more
into non-manufacturing activities
Source: Fort et al. (2018). 18
© 2021 Worth Publishers
International Economics, 5e | Feenstra/Taylor
Conclusion
• Trade can have substantial structural effects.
• In the US (and other advanced economies), globalization has
especially harmed the manufacturing sector (2 million job losses
could be attributed to the China shock in the US).
• In the short run, this creates localized devastating effects: plants
shut down, contractors and local suppliers lose their main partner,
local businesses fall apart, real estate value collapses, tax revenue
plummets…
• This triggers a downward spiral.
• This highlights the existence of market failures: workers are not
perfectly mobile and skills are not always transferable.
• This provides an impetus for proactive public policies: adequate
safety nets, investment in physical capital (infrastructure) and
human capital (education, retraining programs, healthcare).
• Also… tax heavens are bad!