What is the Stolper-Samuelson theory? How does this provide a warning to wealthy nations about trade with developing nations? Analyze the current view of this theory and provide evidence in support or as a critique.
Stolper-Samuelson Theorem (SS Model)
Stolper-Samuelson Theory demonstrates that when the prices of output change, prices of the factors also change. The theory, which is derived from Heckscher–Ohlin model and works within this framework, also asserts that the returns on a factor also change, as prices of output change. In the context of international trade, the theory predicts that return on the scarce factor will reduce gradually, if all other influences are ignored (ceteris paribus), causing a decline in wages. Another assumption of the theory is that as trade increases, it becomes more difficult to reallocate resources (Pareto Optimal).
The earlier models, based on Stolper-Samuelson model theory, were simple as they operated within the framework of Heckscher–Ohlin model; however, more dynamic, and robust models are recently developed that take in the account number of factors, which include classification and mobilization of skilled and unskilled labor. Therefore, the recent models can predict the outcomes of changes in trade, such as trade liberalization.
The theory also subtly implies that factor prices are similar in those countries/economies, which have similar structure and technology. Therefore, the difference in output prices would not be drastic, reducing output price effect on factor prices. The theory also claims that when an economy opens up, its abundant resource benefits, whereas its scarce resource/factor loses. Also, the prices of the traded goods affect factor prices throughout the economy, making an apparent relation between wages and output prices (Stone & Cavazos Cepeda, 2012).
The basis of between Developing and Developed Countries
In the last three decades, the size of international trade has grown abnormally. There are several factors and perceptions which have contributed to the increase in the volume of world trade. One of the factors/perceptions is the Ricardian concept of Comparative Advantage (associated with both Heckscher–Ohlin and Stolper-Samuelson Models). As per this economic notion, an economy would produce those products and services, in which it has a comparative advantage. Based on this principle, the size of international trade swelled gradually, which is now affecting, in some ways, both developing and developed economies.
As per theory, a country exports that good that are produced by abundant resources. As the prices about output change, so do the factor prices. It means that liberalization of trade will shift income towards developing countries, where unskilled labor is in abundance (Davis, 2017).
The pattern of Trade and SS Model’s Prediction (Warning)
It has already been established in this economic discourse that economies tend to rely on their most abundant factor to produce those goods that are to be traded internationally. In the case of developing countries, which are labor-intensive economies, the most abundant factor is unskilled labor, which is employed for mass production. As the size of international trade increases, so does the employment of most abundant resources, which reduces both prices in the international market and returns on a factor. For instance, when products compete in international markets, they tend to lower the prices, which affects nominal wages. Therefore, the pressure mounts to input and production process as they are seen as the means to reduce the cost of production that is reflected in prices.
It is also apparent that mostly it is labor-intensive economies that have a trade surplus, whereas the developed economies have a trade deficit. For instance, the trade deficit of the United States, with China, was $385 billion, whereas, with Mexico, it was $64.1 billion in 2017. These trade deficits with developing countries affect developed countries in some ways. It directly affects nominal wages, because of the competition, it causes unemployment because of de-industrialization, and it reduces the size of aggregate consumption (the considered engine of economic growth) (United States Trade Representative, 2018).
These outcomes of trade liberalization are by warnings of Stolper-Samuelson Theorem, which projects those developing economies would benefit more from trade between developing and developed economies making trade unfair and titled.
Trade (% of GDP) Graph
Trade (% of GDP) Graph Adapted from World Bank Group. (2018, May 26). Trade (% of GDP). Retrieved from https://data.worldbank.org/indicator/NE.TRD.GNFS.ZS
Analysis and Opinion
It is quite evident from the statistics that developing economies have not only benefitted from an increase in the size of world trade, but also, they have caused a decrease in nominal wages and deindustrialization in some of the developed countries. Most of the studies suggest that changes, such as a shift in income, changes in nominal wages and deindustrialization are caused primarily because of trade size and trade pattern between developing and developed economies. However, some studies suggest that there are other factors that are responsible for these outcomes. For instance, there have been several instances where no shift in income has been systematically observed towards an abundant resource country. Therefore, we can say that Stolper-Samuelson Theory’s capacity to project or predict is limited (Michael, 2016). For instance, in many developing countries, after trade liberalization, nominal wages rose (of skilled and unskilled labor).
Also, as it is a quite simple model; therefore, it does not take in account various other economic factors, which are essential to understanding how trade affects developed and developing economies.
Conclusion
Stolper-Samuelson Theory (and the model based on it) aids in explaining current trade deficit and de-industrialization in developed countries; however, it fails to accurately project and explain changes in factor prices in both developed and developing countries. For instance, in several Latin countries, nominal wages rose because of liberalization in trade, contradicting projections of the S-S model. Therefore, we conclude that partly the Stolper and Samuelsson Theory is relevant and aids in understanding changes in the economy because of liberalization of trade, partly it fails to project and explain changes in wages and a shift in income.
References
Davis, D. R. (2017). Trade liberalization and income distribution. Retrieved from http://www.nber.org/papers/w5693
Michael, A. M. (2016). Evaluating Stolper-Samuelson: Trade Liberalization & Wage Inequality in India. Retrieved from https://repository.usfca.edu/cgi/viewcontent.cgi?article=1220&context=thes
Stone, S. F., & Cavazos Cepeda, R. H. (2012). Chapter 2: Wage Implications of Trade Liberalisation: Evidence for Effective Policy Formation. In Policy Priorities for International Trade and Jobs. OECD Publishing.
United States Trade Representative. (2018, January 1). U.S.-China Trade Facts. Retrieved April 18, 2018, from https://ustr.gov/countries-regions/china-mongolia-taiwan/peoples-republic-china#
World Bank Group. (2018, May 26). Trade (% of GDP). Retrieved from https://data.worldbank.org/indicator/NE.TRD.GNFS.ZS
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