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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. This question will ask you to analyze what effect Brexit (the UK’s exit from the EU) may have on relative wages for high-skilled and low-skilled workers in the UK using the Heckscher-Ohlin model of international trade. 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 labor (i.e. it has relatively more high-skilled workers than the rest of the EU).

a) Show using the Heckscher-Ohlin model of international trade how relative wages for lowskilled 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 highskilled workers change (remember that the UK is abundant in high-skilled labor)? Explain your answer.

c) Describe also how the relative output of financial services versus manufacturing in the UK changes with Brexit. Explain your answer

Answer 1

Information given:

2 industries: financial services and manufacturing

2 factors of production: low skilled and high skilled workers

FINANCE- high skill intensive; MANUFACTURING- low skill intensive

UK is abundant in high skill labor

a) When UK is a member of EU, there is free trade between them. But, as a result of trade, the quantity that is abundantly available in UK won't suffer and its price will increase as a result of trade compared to what they would without trade. So, UK will export high skill labor and import low skill labor as a result of which the low skill labor present in Uk will suffer as the competition within them will increase for low skill labors. Due to the H-O model, the price of huigh skilled labors will increase and that of low skilled labors will fall

b) If UK leaves the EU, it would be an autarky situation i.e. that of no trade. The high skilled workers will suffer due to this and their price will decrease thus their real wages will decrease, but the real wages of low skilled workers will increase which were suffering due to free trade with EU and high competition.

c) PRESENCE OF TRADE : As finance is highly skill intensive, it will export financial services and thus its price will increase as a result of trade, and as manufacturing is low skill intensive, it will import such services and its prices will decrease( the reason why it is importing is cheap prices) and owners of manufacturing services within UK will suffer.

ABSENCE OF TRADE: In the absence of trade, the opposite will take place i.e. Finance will suffer and its price will decrease within the country as it was earler benefitting due to trade, and manufacturing activities will be priced higher than the trade situation as now they wont be importing manufacturing services from outside and people will have to therefore undertake domestic manufacturing servicing products and it'll flourish as a result.