Factor Heterogeneity, Factor Market Imperfection and Trade

ABSTRACT

This paper develops a tractable model of examining how factor heterogeneity and imperfect factor market interact for determining a pattern of trade. Institution plays a crucial role for the interaction. In my work, firm productivity is defined as a composition of factor productivity and technology. Thus, input selection should affect the pattern of Melitz’s intra-industry allocation due to the incurring transaction cost. For a simple model, I assume two factors (labor and capital) and two sectors, which are relatively less institution-dependent and relatively more institution-dependent. When the economy is open, effect of the transaction cost on income distribution is more drastic for an institutionally underdeveloped country. Depending on institutional quality, the economic openness reallocates resource across countries through job creation or job destruction. The job turnovers redistribute income between heterogeneous labors within countries. The income redistribution is catalyzed by international mobility of capital. As a result, income disparity is widened between the institutionally developed country and the institutionally underdeveloped country. This paper can contribute to the literature of institution and international trade.

KEYWORDS:

• Factor heterogeneity
• institution
• international trade
• monopolistic competition

JEL CLASSIFICATIONS:

• F12
• C73
• L13

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1 In extending the work of Melitz (2003), the threshold levels of factor productivities should be met coincidentally. Otherwise, firm entry is impossible. Thus, mass of firms should be reduced substantially.

2 Recent studies show that proper selection of intermediate inputs can improve firm productivity. According to the studies, access to better inputs improve firm productivity in some countries, including Indonesia (Amiti & Konings, 2007), Chile (Kasahara & Rodrigue, 2008), India (Topalova & Khandelwal, 2011), and Hungary (Halpern, Koren, & Szeidl, 2015). Overall, the studies show that improved access to better inputs ends up with increasing firm productivity in the countries.

3 Here, the transaction cost is similar as ‘searching cost’, introduced by Helpman et al. (2010), to screen unobservable abilities of workers in their model. Instead of the term, ‘searching cost’, I will use transaction cost.

4 Melitz and Ottaviano (2008) showed how tougher competition can endogenize the mark-up in differently assuming the consumer’s preference. They derived the indirect utility of consumer that depends negatively on average of prices for varieties and positively on variance of the prices. In assuming Pareto distribution of productivity, they explicitly found the threshold level of firm productivity. However, firm productivity might not follow the Pareto distribution. In the work of Nigai (2017), he proposed using a parametric distribution that models the left tail as Log-normal and right tail as Pareto. Otherwise, I use the general equilibrium model of trade with heterogeneous firms would meet incorrect calculation of trade gain.

5 In Samson (2014), he considered labor productivity and firm productivity, separately to show how firm selection affects income distribution between heterogeneous factors. In my work, firm productivity is a result of factor selection, interacting with technology.

6 Capital mobility between countries was initially analyzed by Mundell (1957), and followed by many researchers like Markusen (1983) and Neary (1995). The main point of the discussion was on complementarity or substitutability between commodity trade and factor mobility. In my work, factors move for a greater return while commodity trade do not perfectly equalize the factor prices.

7 In many papers, completion or incompletion of contract is discussed. In my work, transaction cost is a measure of how the contract is incomplete. The completion leads to the less transaction cost while the incompletion to the more transaction cost.

8 Here, the variability of factor means that firms face risk. Grossman and Maggi (2000) pointed out that the variance of worker types in one country determines a comparative advantage.

9 The median factor is assumed to be indifferent between choosing industry 1 and choosing industry 2.

10 In his work, he assumed joint production and individual production. Automobile industry is a typical example of team production while software industry is of individual production.

11 The exogenous shock might be a political event, which can cause sudden changes of regulations for factors.