Question

Many reasons for why the United Kingdom voted to leave the European Union have been proposed. A common one is that imports from the EU hurt low-skilled British workers. Suppose that there are two industries, financial services and manufacturing. Further assume that there are two factors of production, low- skilled and high-skilled workers, and that finance is high-skill intensive and manufacturing is low-skill intensive. Further assume that the United Kingdom is abundant in high-skill labour.

a) Show using the Heckscher-Ohlin model of international trade how relative wages for low-skilled and high-skilled workers are determined when the UK is a member of the EU (i.e. when there is free trade between the UK and the rest of the EU). Explain your answer.

b) Now suppose that the UK leaves the EU. For simplicity, we will model this as autarky (i.e. that all trade between the UK and the EU stops). How do real wages of low-skilled and high-skilled workers change (remember that the UK is abundant in high-skilled labour)? Explain your answer.

Answer 1

Sol. (a) In the given question there are two countries UK and the rest of EU( lets assume EU is another country for the sake of simplicity).

And two factors of production HIGH SKILLED labour and low skilled labour.

UK is abundant in high skilled labour and EU is abundant in low skilled labour.

Two industries financial services which is high skill intensive and manufacturing which is low skill intensive.

Heckscher-Ohlin model of international trade states that a country exports a good which is relatively intensive in factor of production that is relatively abundant in that country.

So UK would import manufacturing and export financial services. As a result wages of low skilled labour would decrease in UK because the country imports manufacturing from the EU which has advantage in production of low skill intensive goods.and services.

and relative wages of high skilled labour would increase as it has another market for financial services outside of UK i.e, rest of EU.

(b) In the situation of autarky relative wages of low skilled labour would increase and relative wages of high skilled labour would fall as no trade takes place and both the manufacturing and financial services has to produce and render services domestically and would cater the domestic market only.