Question

1. “The Stolper-Samuelson Theorem is useful in explaining the distributive effects of both inter-industry and intra-industry trade”. Do you agree/disagree with this statement? Why? State the theorem and discuss its relevance to both cases.

Answer 1

The Stolper-Samuelson theorem states that the increase in the relative price of a commodity increases the reward of the factor used intensively in the production of the commodity.

According to this theorem, the export of the product that embodies large amounts of the relatively cheap, abundant resource makes this resource more scarce in the domestic market. Thus, the increased demand for the abundant resource results in an increase in its price and an increase in its income. At the same time, the income of the resource used intensively in the import-competing product (the initially scarce resource) decreases as its demand falls. The increase in the income to each country’s abundant resource thus comes at the expense of the scarce resource’s income.

International trade is traditionally thought to consist of each country exporting the goods most suited to its factor endowment, technology, and climate while importing the goods least suited for its national characteristics. Such trade is called inter-industry trade because countries export and import the products of different industries. Intra-industry trade occurs when a country exports and imports goods in the same industry.

To assess real income changes, however, these changes in nominal income need to be compared to the relative product price changes induced by trade. Under perfect competition, the average prices of the factors employed in the export sector, for example, will increase by the same amount as the price of the export good. Since the abundant factor is not the only factor employed in this sector, the rise in its nominal relative factor price means that its nominal price must also rise relative to this average, and hence relative to the price of the export good. The abundant factor's real income therefore increases in terms of the export good. This is known as the magnification effect, whereby the price of a factor changes relatively more than the price of the good intensive in that factor. The abundant factor's real income must therefore rise unambiguously (i.e. in terms of both goods) with the opening of trade, since the relative price of the importcompeting good falls with trade

With the opening of trade there will be two effects. First, conventional distribution effect which will harm the specific factor in the sector with an overall comparative disadvantage, and benefit the specific factor in the sector with an overall comparative advantage. Secondly, since different countries produce products which are imperfect substitutes in consumption, there will be an increase in the variety of products available, which will benefit everyone. Both effects benefit the abundant factor, which will therefore gain unambiguously.

Therefore, both countries will gain from mutual or bilateral trade liberalisation in an industry if neither country has too great a comparative advantage and if products are strongly differentiated within that industry, since it is then possible for both productive factors to gain from trade. This suggests that the adjustment to trade liberalisation is likely to be easier when the growth in trade is of the intra-industry type rather than the inter-industry type, which in turn is more likely to be the case between countries with similar factor endowments