Chapter 5 The Basic Economics
of Trade in services
The basic questions of
international trade theory
 What is the basis of trade?
 What is the pattern of trade?
 What are the gains from trade?
Comparative advantage
 The law of comparative advantage shows
how mutually beneficial specialization and
trade may be driven by relative advantages
in production rather than absolute
advantages in production.
Factor-Endowment Theory
 A nation will export the commodity whose
production requires the intensive use of the
nation’s relatively abundant (and therefore,
cheap) factor, and import the commodity
whose production requires the intensive use
of the nation’s relatively scarce (and
therefore, expensive) factor.
Factor endowment model
Comparative advantage according to
factor endowment theory
Autarky equilibrium
Factor endowment model
Comparative advantage according to
factor endowment theory
Post-trade equilibrium
Stolper-Samuelson theorem
Country A( Capital abundant)
Commodity Y
Labor intensive
Commodity X
Capital intensive
Export X
Import Y
Increase the production of X
Demand for the factor input
Decrease the production of Y
Release the factor input
Demand for more capital Demand for less labor
Supply less capital
The price of capital rise
Supply more labor
The price of labor decrease
Bringing theory closer to reality
Specific factor theory
 Looks at the income distribution effects of trade
in the short run, when some factor inputs are
not mobile among sectors
 Indicates that workers may be better or worse
off, depending on preferences
 Predicts that owners of factors used in export
industries gain from trade, while owners of
factors used in import-competing industries will
lose from trade
Bringing theory closer to reality
Relative prices and the specific factor model
Intra-industry trade
 Economies of scale
 Variety of production
Overlapping demands
Product life cycle theory
Economies of scale
Economies of scale as basis for trade
quantity
International Product Life Cycle
3-12
Theory of FDI
OIL theory( Ownership Internalization
location)----by Dunning
 ownership advantage
 location advantage
 Internalization advantage
What the characteristics of services?
 Intangible/invisible
 Un-storable
 simultaneous production and consumption
How services are trade?
 Modes of trade in service
(1) Cross-border
(2) Consumption abroad
(3) Commercial presence
(4) Presence of natural persons
The classification of services
Range of services covered by the GATS
The difference between trade in
goods and trade in service
 cross-border trade is not the most important
for trade in service.
 Services tend to be highly regulated.
 Barriers to trade in service often serve the
dual purpose.
Change of supply mode of
international trade in services
Cross border
supply
Movement of
natural person
Consumption
abroad
Commercial
presence
Class Discussion
According to the OIL theory, what advantages following will decide
supply mode of trade in services ?
Supply modes of trade
in services
Cross-border supply
Consumption abroad
Commercial presence
Movement of natural
person
Ownership
advantage
Internalization
advantage
Location
advantage
Basic economics of trade in service
The causes and patterns of trade in
services
Situation 1:Trade between different countries
 Comparative advantages
Call centers in India
provide customer contact
services for US firms
Nannies from Philippines
move to Canada temporarily
to provide childcare services
Comparative advantage cause the trade in
service
 Differences in factor abundance、technology 、
institution and policies.
 The price differences create incentives to trade.
Gains of trade in services caused by
comparative advantage
 Producers gain from access to a larger
market and higher prices.
 Consumers gain both a wider variety of goods
and services and to lower-priced imported
goods and services.
Welfare effects of service trade
 Bhawati(1965)
Two countries: home and abroad
Two factors of production: capital and
lawyers
One service: legal services which is traded
by the movement of lawyers to the location
of the consumers.
Welfare effects of service trade
The effects of trade in services
International income distribution
 If the movement is permanent migration
The welfare of those left at home declines
by the amount ACE.
Welfare of those originally abroad increase
by ABD.
Welfare of the migrants increase by ADCE.
 If the movement is temporary and substantial
remittance
The welfare of home will increase by ADC
The welfare of abroad will increase by ABD
National income distribution
Lawyers remained at home receive higher
returns equal to the amount AEMN;
capital at home loses by an amount of ACMN;
Lawyers who originally worked abroad loses by
BPQD;
capital abroad benefits by an amount PBAQ.
Trade in inputs
 The argument for gains from trade applies
both to goods and services destined directly
for final consumers, as well as to those used
as an input into production.
 Imports of producer services can lower costs
of firms in the export sector and thereby
stimulate exports.
Why trade in service can emerge
between similar countries?
Reasons of trading among the similar countries
Increasing returns to scale
Sources of increasing returns
■ Fixed
costs combined with market niches
variety of products available
larger market
Specialized service viable in a small country
■ Firm-specific
intangible assets
eg. McDonald’s fast-food franchises.
firm-specific fixed costs
plant-level fixed costs
■
Agglomeration effects
positive externalities
1. Spillover effects across firms.
2. Common pool of specialized labor.
3. Infrastructure which address the needs of a
specialized industry.
Interaction between scale economies and
transportation cost or trade barrier
Agglomeration can be self-reinforcing?
Gains and distributional effects of
agglomeration-driven trade
The core area gain from trade and those who
live in the periphery may lose from trade. The
partial trade liberalization could hurt the periphery.
The core does not have an incentive to eliminate all
barriers to trade.
■
Networks
In some service sectors, the efficiency,
quality and benefits to consumers of the services
provided depend on access to networks of other
consumers and producers.
The analysis of benefits of liberalizing trading
rules to allow smoother access to international
networks is complicated by two important factors.
Welfare implications
 Gains from trade:
 Greater diversity of services
 Firms can reap greater economies of scale
 Transfer of technology and know how
 Income distribution effects less significant
Modes of supply of trade in service
Three questions
 If trade in all modes was unconstrained, how would
firms choose to supply services to their foreign
customers?
 Are different modes substitutes or complements?
 What is the effect of allowing trade via some
modes but not others?
Asymmetric costs across modes of Supply
 For many types of services, the costs of provision
vary substantially across the different modes of
supply.
 For some services, supply is essentially not
feasible via some modes.
 Rules that allows some modes but not others will
favor some countries over others.
The rules affecting different modes of supply can
be important both in determining which services will
be traded, and in determining the distribution of the
gains from trade across countries.
Modes of supply as Substitutes
 For some types of services, different modes of
supply are substitutes.
 If the different modes of supply are substitutes, in
some cases virtually all of the gains from trade can
be realized by opening up just one mode of trade.
 But, in some cases, when modes of supply are
substitutes, restrictions on which modes are
available to firms can have important implications.
un-perfect substitute
different modes have different effects on income
distribution
Modes of supply as Complements
 In cases where there are strong
complementarities across different modes of
supply, fully effective liberalization of service trade
requires that all modes be opened up.
 Services may also be complementary with goods
trade.
 In some cases, the potential gains from goods
trade cannot be fully realized without liberalization
of service trade.