Trade and Employment From Myths to Facts - International Labour ...

Trade and Employment: From Myths to Facts
3.3.2.3 Assessing the two-sector substitution model
The strength of the two-sector factor substitution models approach is its simplicity
and clarity in regard to basic principles of economics. 24 Factor share models are relatively
cheap and easy to implement: Cobb-Douglas equations can be easily estimated
and factor shares deduced. Since the wage bill is constant, two-sector substitution
models based on Cobb-Douglas production functions can predict whether there
will be a large quantity of new jobs with low wages or the reverse, so long as workers
are paid their marginal product. In non-competitive environments, studded with
minimum wages and other labour-market distortions, the marginal product of labour
may be scarcely relevant. It is still possible, however, to say that if demand shifts
from a sector with a low share of labour to one with a high share of labour, workers
in some form or other will probably benefit.
A weakness of the HOS-inspired labour share approach is that it does not
often take into account inter-indus try relationships as do the input-output models
discussed below. A second weakness of this approach is that the whole of traditional
trade theory in the mould of HOS seems to be at variance with what is observed
in the current trading arena (Hertel and Keeney, 2005). A serious objection to the
HOS view of the world is that sectoral reallocation along the lines predicted does
not typically take place. Instead, a sector expands to meet an increase in export demand.
In exchange, the home country receives an import from the same sector of
the trading partner’s economy. No factors are reallocated. Both sectors must either
experience a rise in labour productivity or increased employment. Aggregate employment
will then rise if there was slack in the labour market initially and wages
will increase otherwise. Referring to the effects of the formation of the European
Economic Community (EEC) and the US-Canadian auto agreement, Hertel and
Keeney (2005) observe:
24 The HOS model does not allow for the possibility of intra-industry trade, i.e. the type of trade
that typically takes place between industrialized countries. Although the bulk of trade still occurs
between industrialized countries, trade between sectors with different capital labour ratios and radically
different wages is still important and arguably increasingly so because of the increasing role
of developing countries in global trade. The HOS model thus remains a valid instrument for trade
analysis.
25 These models have their roots in the model first described by the young Harvard graduate student
W. Leontief just after the turn of the century.
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“Little resource reallocation took place; instead, trade seems to have
permitted an increased productivity of existing resources, which left
everyone better off.”
3.3.3 Input-output framework
3.3.3.1 Taking into account indirect employment effects
The next step is to introduce multi-market equilibria by way of an input-output
framework, a halfway house to the full general equilibrium specification. 25 These