Since the mid 1980s Australia has been steadily reducing the level of protection on its imports.
a) What are some of the models that predict the EFFECT that REDUCING PROTECTION OF IMPORTS will have on FACTOR PRICES? Briefly explain the effects shown by these models.
Note: I am looking for at least 3 different models, unless there are only 2. b) How useful are these models in analyzing a country like Australia?
EFFECT that REDUCING PROTECTION OF IMPORTS will have on FACTOR PRICES:
While trade improves a nation's welfare, not all segments of the economy necessarily benefit. For example, in many developing nations, labor is relatively abundant and consequently prevailing wages are much lower than those in the Australia. As a result, firms in these countries can produce many labor-intensive products at lower cost than domestic firms. Moreover, a domestic industry that has successfully competed in international markets may become less successful over time. It might lose its competitive edge, for example, if its technology became standardized and readily appropriable by foreign firms.
In the short run, the primary benefit of protection in a fully employed economy is that workers who would have been laid off remain productively employed during what otherwise would have been a spell of unemployment. If the industry has not adjusted during the period of protection, however, the economy will have to bear costs of adjustment once the restraints lapse. If the industry does adjust in the long run, the primary benefit will be that the economy has been spared the costs of workers being unemployed and the additional costs of their finding and training for new jobs. Although a protected industry will be larger as a result of restraints, in a fully employed economy other sectors will consequently be smaller. Society does not necessarily benefit from such transfers of resources.
A common source of the difficulties that domestic industries encounter is that their costs, and particularly their labor costs, are substantially higher than those of foreign producers. In fact, foreign producers may have lower costs even though they are less efficient; the lower price of inputs more than compensates for their more intensive use. In such situations, protection is supposed to enable an industry to improve its competitive position, but it does so only indirectly. First, restricting imports increases their price. Second, the resulting increased demand for domestic substitutes raises the prices, output, and profits of the domestic industry. Finally, higher profits enable domestic firms to invest either in new cost-reducing technologies or new products.
Trade protection cannot be expected to increase substantially a firm's incentives to invest in cost-reducing technologies. The higher output and prices that result from protection do not significantly affect the profitability of such an investment. If a new technology is supposed to reduce average costs by 10 percent, it would do so whether or not the industry was protected.
Increasing profits, however, may make it easier for a firm to obtain funds and thereby increase the expected profitability of investments. Thus, protection might restore an industry's cost competitiveness if it failed to make cost-reducing investments because of a lack of resources. If capital markets are reasonably efficient, however, then companies should be able to secure the requisite funds at an appropriate cost. In any case, if a lack of funds for investment is the source of an industry's problem, it would be less costly to the economy to provide the resources directly to the firm through loans or loan guarantees rather than indirectly through protection.
IN ANALYSING A COUNTRY LIKE AUSTRALIA
There is in fact a respectable basis in economic theory for the proposition that free trade will undermine real wages of those toward the bottom of the distribution. Economists Eli Heckscher and Bertil Ohlin developed in the 1930s the theory that a country exports goods that are intensive in the use of its "abundant" factor (for the Australia, skilled labor) and imports goods that intensively use its "scarce" factor (unskilled labor). Economists Wolfgang Stolper and Paul Samuelson further developed this theory in the 1940s to show that it implied trade liberalization would reduce the real wages of the scarce factor and increase those of the abundant factor. Essentially, more export opportunities would bid up wages of those primarily producing export goods while increased competition from imports would tend to bid down wages of workers producing substitutable goods domestically.
Many other factors than trade, however, have played a role in trends for skilled and unskilled wages, notably including rapid technological change, deunionization, and an eroding real minimum wage. In the mid-1990s a large economics literature developed seeking to disentangle the relative contributions of trade and other influences. Implicitly or explicitly the economists contributing to this literature mostly shared the analytical framework..
This framework views wages of skilled workers relative to those of unskilled workers (vertical axis) as the outcome of the interaction between supply and demand in the labor market. The quantity of skilled labor available relative to that of unskilled labor is shown on the horizontal axis. For example, ...
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