Where are the missing gains from trade?

by on January 21, 2014 at 2:37 am in Economics | Permalink

There is a new and probably important paper by Marc J. Melitz and Stephen J. Redding on this topic.  For this piece I find a segment in the middle to be more illuminating than the abstract:

Trade has a fractal-like property in this model, in which there are gains from trade at each intermediate stage of production.  If one falsely assumes a single stage of production, when production is in fact sequential, these gains from trade at each intermediate stage show up as an endogenous increase in measured domestic productivity.  As the number of production stages converges towards infinity, the welfare gains from trade become arbitrarily large.  This captures the idea that trade involves myriad changes in the organization of production throughout the economy and the welfare costs from forgoing this pervasive specialization can be large.

As the domestic trade share for an individual production stage becomes arbitrarily small, the welfare gains from trade also becomes arbitrarily large.  This captures the idea that some countries may have strong comparative advantages in some stages of production and the welfare losses from forgoing this specialization can be large.

Here is an ungated version of the paper.  I would note this idea holds out the hope of integrating the technology diffusion literature with the more traditional international trade theory approaches.

prior_approval January 21, 2014 at 3:58 am

‘these gains from trade at each intermediate stage show up as an endogenous increase in measured domestic productivity’

More middlemen – it is just what the American economy needs in an age where average is over.

Except for such pesky companies as Amazon having another vision with something like the Kindle, replacing such intermediate trade stages as logging, paper bleaching, printing, physical delivery, book stores, etc.

‘This captures the idea that trade involves myriad changes in the organization of production throughout the economy and the welfare costs from forgoing this pervasive specialization can be large.’

The dying book printing industry thoroughly supports this perspective.

Amazon – the lurking enemy preventing America from becoming a paradise on earth for middlemen.

And less us not even discuss authors that self-publish, selling directly through the Internet, or by using a single middleman like Amazon. Such selfish authors are obviously uncaring about forgoing the welfare costs of foregoing the existing book printing industry.

Let us not even talk about the music industry, still increasing our welfare by selling CDs of decades old music at the low, low cost of $9.99.

8 January 21, 2014 at 4:39 am

In the Austrian model, the growing intermediate stages are due to specialization. What was once done all in house at a car company, for example, is now outsourced across a myriad of specialized firms, from marketing to steel.

Everything can be solved by high oil prices. Then shipping costs will rise and global trade will plummet, moving millions of manufacturing jobs back onshore to the United States (and Amazon gets hit too!). All you need is some really bad monetary policy combined with a batshit crazy Middle East foreign policy. Hmmm……..

Benny Lava January 21, 2014 at 8:28 am

Well there was that oil shock in the 1970s, which was followed by a decline in manufacturing employment. And again in 2008, which was followed by a decline in manufacturing employment. Boy it’s almost like ABC has everything backwards.

Bob January 21, 2014 at 1:15 pm

I wonder what the proper modeling of something like Amazon and Walmart looks like. While they are single firms, departments have the levels of specialization that one would find in different companies. But what separates their relative success from the problems faced by japanese zaibatsus that piled uncompetitive firm on top of uncompetitive firm?

Ian Maitland January 21, 2014 at 10:14 am

A vivid illustration of this point may be found in Oxfam’s study of the impacts of Unilever in Indonesia some ten years ago. I think the findings came as a surprise to Oxfam which likely has back-slid since then.

Key findings

Our key finding from the research was that the potential poverty reduction impacts of a company such as Unilever Indonesia are spread across the full breadth of its value chain: the long chain that links raw materials providers and other suppliers to the manufacturing of products, then through product distribution and retail outlets to the consumer.

Unilever Indonesia employs about 5,000 people, of whom 60% are direct employees and 40% are contract workers. In addition, nearly 2,000 people are employed in factories solely making Unilever products under contract. Indirectly, however, the full-time equivalent of about 300,000 people make their livelihoods in Unilever Indonesia’s value chain. More than half of this employment is found in distribution and retailing, among an estimated 1.8 million small stores and street vendors.

Of the total value created in 2003 (the year the study focused on), around two-thirds is distributed to participants other than Unilever Indonesia, such as producers, suppliers, distributors, retailers and the Indonesian government, which receives an estimated 26% of the total.

http://www.unilever.com/sustainable-living/betterlivelihoods/impact-studies/indonesia/

Sigivald January 21, 2014 at 6:33 pm

Our key finding from the research was that the potential poverty reduction impacts of a company such as Unilever Indonesia are spread across the full breadth of its value chain: the long chain that links raw materials providers and other suppliers to the manufacturing of products, then through product distribution and retail outlets to the consumer.

I’m surprised they were surprised by that.

(Okay, I’m not, having some inkling of Oxfam’s politics and probable state of economic knowledge.

But still. It’s not like economics is some secret thing nobody tells anyone about; people are nearly shouting from the rooftops that trade and production benefits everyone in the chain.

I guess the problem is that they just never want to believe it.)

Nathanael Snow (@NathanaelDSnow) January 21, 2014 at 11:19 am

“some countries may have strong comparative advantages in some stages of production and the welfare losses from forgoing this specialization can be large.”
Nonsense. Some firms within a particular industry within a certain country may have comparative advantages over some stages of production, but *countries* do not have comparative advantages over productive processes. We know this because generally at most 1/3 of firms within an industry that has been identified as a comparative advantage for a country actually engage in international trade. The other 2/3 are solely domestic enterprises.
Thinking from the nation-state level of analysis is a fail. At best, if a nation does have a comparative advantage in production at the national level it is an accident of entrepreneurs being located in that country to begin with. At worst, a comparative advantage can be explained as the product of subsidies to industries. In that case, a comparative advantage has been purchased at the expense of naturally evolving comparative advantages and is just as likely to be a misallocation of incentives as a successful program.

Finch January 21, 2014 at 1:11 pm

Do firms not experience some advantage from being collocated with other firms in the same industry? It’s easy to operate when common suppliers are across the street, when finding skilled labor is easy, when the regulatory environment is suited to your business, and when the local schools are full of your alumni and teaching the things you need. Think of Silicon Valley or Wall Street. Why would this stop working at a national level? Is there some scale phenomena that makes Singapore or Saudi Arabia different from Texas or Massachusetts?

Joe Smith January 21, 2014 at 1:35 pm

“As the number of production stages converges towards infinity, the welfare gains from trade become arbitrarily large.”

We know that this limiting case is nonsense so the model/equation is nonsense. Did they not learn how to take a limit in second year theoretical calculus courses?

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