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What do Eaton and Kortum see as Ricardo’s main insight? What problems do with the original version of the theory do they think made it difficult to apply in practice? How do they think recent innovations have helped make the theory relevant again?

What was something you didn’t understand in this week’s reading?

Journal of Economic Perspectives—Volume 26, Number 2—Spring 2012—Pages 65–90

W hen presented with the opportunity to trade, countries benefi t by special-hen presented with the opportunity to trade, countries benefi t by special-izing in the activities they do relatively better. This fi nding, the principle izing in the activities they do relatively better. This fi nding, the principle of comparative advantage, is one of the fi rst analytic results in economics. of comparative advantage, is one of the fi rst analytic results in economics. While Adam Smith (1776) made a much earlier case for free trade, he based it on While Adam Smith (1776) made a much earlier case for free trade, he based it on increasing returns to scale, and provided no formal demonstration. In contrast, increasing returns to scale, and provided no formal demonstration. In contrast, David Ricardo (1817) provided a mathematical example showing that countries David Ricardo (1817) provided a mathematical example showing that countries could gain from trade by exploiting innate differences in their ability to make could gain from trade by exploiting innate differences in their ability to make different goods.different goods.

In the basic Ricardian example, two countries do better by specializing in different In the basic Ricardian example, two countries do better by specializing in different goods and exchanging them for each other, even when one country is better at making goods and exchanging them for each other, even when one country is better at making both. This example typically gets presented in the fi rst or second chapter of a text on both. This example typically gets presented in the fi rst or second chapter of a text on international trade, and sometimes appears even in a principles text. The reason is international trade, and sometimes appears even in a principles text. The reason is to demonstrate the gains from specialization and trade in a way that at least a bright to demonstrate the gains from specialization and trade in a way that at least a bright student can absorb quickly. But having served its pedagogical purpose, the model is student can absorb quickly. But having served its pedagogical purpose, the model is rarely heard from again. As one example, Feenstra (2004), the leading Ph.D. text in rarely heard from again. As one example, Feenstra (2004), the leading Ph.D. text in international trade, devotes only three pages to the Ricardian model. During the twen-international trade, devotes only three pages to the Ricardian model. During the twen- tieth century, the theoretical and quantitative analysis of international trade turned tieth century, the theoretical and quantitative analysis of international trade turned fi rst to differences in factor endowments and then to increasing returns to scale as fi rst to differences in factor endowments and then to increasing returns to scale as explanations for trade and its benefi ts. The Ricardian model became something like explanations for trade and its benefi ts. The Ricardian model became something like a family heirloom, brought down from the attic to show a new generation of students, a family heirloom, brought down from the attic to show a new generation of students, and then put back, allowing them to pursue more fruitful lines of study and research.and then put back, allowing them to pursue more fruitful lines of study and research.

Putting Ricardo to Work†

■ ■ Jonathan Eaton is Professor of Economics, Pennsylvania State University, University Park, Pennsylvania. Samuel Kortum is Professor of Economics, University of Chicago, Chicago, Illinois. Their e-mail addresses are ⟨⟨ jxe22@psu.edu⟩⟩ and ⟨⟨kortum@uchicago.edu⟩⟩. † To access the Appendix, visit http://dx.doi.org/10.1257/jep.26.2.65. doi=10.1257/jep.26.2.65

Jonathan Eaton and Samuel Kortumhttp://dx.doi.org/10.1257/jep.26.2.65

66 Journal of Economic Perspectives

Nearly two centuries later, however, the Ricardian framework has experienced Nearly two centuries later, however, the Ricardian framework has experienced a revival. Much work in international trade during the last decade has returned to a revival. Much work in international trade during the last decade has returned to the assumption that countries gain from trade because they have access to different the assumption that countries gain from trade because they have access to different technologies. These technologies may be generally available to producers in a technologies. These technologies may be generally available to producers in a country, as in the Ricardian model of trade, our topic here, or exclusive to individual country, as in the Ricardian model of trade, our topic here, or exclusive to individual fi rms, as Marc Melitz and Daniel Trefl er discusses in the companion paper in this fi rms, as Marc Melitz and Daniel Trefl er discusses in the companion paper in this issue. This line of thought has brought Ricardo’s theory of comparative advantage issue. This line of thought has brought Ricardo’s theory of comparative advantage back to center stage. Our goal is to make this new old trade theory accessible and to back to center stage. Our goal is to make this new old trade theory accessible and to put it to work on some current issues in the international economy.put it to work on some current issues in the international economy.

Revisiting Ricardo’s Example

Ricardo (1817) posited a world of two countries, England and Portugal, which Ricardo (1817) posited a world of two countries, England and Portugal, which can make each of two goods, cloth and wine. What he assumed about how many can make each of two goods, cloth and wine. What he assumed about how many workers it takes to make a unit of each good in each country appears in Table 1. workers it takes to make a unit of each good in each country appears in Table 1. Since the workers required to make one unit of a good are the same no matter how Since the workers required to make one unit of a good are the same no matter how many units are produced, Ricardo was assuming constant returns to scale.many units are produced, Ricardo was assuming constant returns to scale.

Ricardo argued that trade could allow England to obtain a unit of wine with Ricardo argued that trade could allow England to obtain a unit of wine with the effort of only 100 workers (instead of 120) and Portugal to obtain a unit of cloth the effort of only 100 workers (instead of 120) and Portugal to obtain a unit of cloth with the effort of only 80 workers (instead of 90)—the outcome if international trade with the effort of only 80 workers (instead of 90)—the outcome if international trade established an international price of 1 unit of cloth exchanging for 1 unit of wine.established an international price of 1 unit of cloth exchanging for 1 unit of wine.

Of course, to our twenty-fi rst century eyes, Ricardo’s example is very incomplete. Of course, to our twenty-fi rst century eyes, Ricardo’s example is very incomplete. For example, he does not explain what assumptions about tastes, endowments, or For example, he does not explain what assumptions about tastes, endowments, or competition are needed for this world price ratio of 1 to arise. However, in using competition are needed for this world price ratio of 1 to arise. However, in using this example Ricardo was advocating policy in a very modern way. He compared an this example Ricardo was advocating policy in a very modern way. He compared an actual world with one policy—trade prohibited—with a counterfactual world of free actual world with one policy—trade prohibited—with a counterfactual world of free trade. In making the comparison, he described each world in terms of a common trade. In making the comparison, he described each world in terms of a common set of parameters, the labor requirements in Table 1, that are plausibly exogenous set of parameters, the labor requirements in Table 1, that are plausibly exogenous to the policy in question, thus immunizing himself to the Lucas critique (1976) of to the policy in question, thus immunizing himself to the Lucas critique (1976) of the following century.the following century.11

Why, when the Ricardian model delivers such a slick demonstration of the gains Why, when the Ricardian model delivers such a slick demonstration of the gains from trade, did it hit such a dead end in terms of providing a framework for more from trade, did it hit such a dead end in terms of providing a framework for more sophisticated and quantitatively meaningful analysis? A major reason is that even this sophisticated and quantitatively meaningful analysis? A major reason is that even this basic formulation gives rise to different types of equilibria that need to be analyzed basic formulation gives rise to different types of equilibria that need to be analyzed separately. Even in Ricardo’s minimalist setting, three types of outcomes are possible: separately. Even in Ricardo’s minimalist setting, three types of outcomes are possible: 1) England makes only cloth and Portugal only wine, 2) England makes both cloth 1) England makes only cloth and Portugal only wine, 2) England makes both cloth and wine and Portugal only wine, or 3) England makes only cloth and Portugal both and wine and Portugal only wine, or 3) England makes only cloth and Portugal both

1 Chipman (1965), in his magnifi cent three-part survey of the theory of international trade, attributes the fi rst complete statement of a Ricardian equilibrium to Mill (1844), who implicitly assumed what we now call Cobb–Douglas preferences, with equal shares for each good. Using the labor requirements in Table 1, the reader can verify that Ricardo’s posited price of 1 will then emerge if Portugal has 80 percent as many workers as England.

Jonathan Eaton and Samuel Kortum 67

cloth and wine. In case 1, the one assumed in Ricardo’s example, outputs can be cloth and wine. In case 1, the one assumed in Ricardo’s example, outputs can be immediately solved for from labor endowments, with prices then determined by immediately solved for from labor endowments, with prices then determined by demand. In the second two, relative prices are given by the relative labor requirements demand. In the second two, relative prices are given by the relative labor requirements in the incompletely specialized country, with demand then determining outputs. At in the incompletely specialized country, with demand then determining outputs. At the intro level, the lesson from his sort of example is that gains from trade are possible, the intro level, the lesson from his sort of example is that gains from trade are possible, although we can only put bounds on what the gains are. At a more advanced level, although we can only put bounds on what the gains are. At a more advanced level, students are told to solve for the equilibrium outcome by assuming one case and then students are told to solve for the equilibrium outcome by assuming one case and then checking that it satisfi es the requirement that prices don’t exceed costs or that labor checking that it satisfi es the requirement that prices don’t exceed costs or that labor is fully employed. Already the model has to confront a clumsy taxonomy.is fully employed. Already the model has to confront a clumsy taxonomy.

International trade is a fi eld rich in data. United Nations COMTRADE, International trade is a fi eld rich in data. United Nations COMTRADE, currently the major source of statistics on merchandise trade, reports the annual currently the major source of statistics on merchandise trade, reports the annual value of bilateral trade between over 242 countries (making for 242 value of bilateral trade between over 242 countries (making for 242 ×× 241 241 == 58,322 58,322 bilateral pairs) in 776 product categories going back to 1990. Given that even bilateral pairs) in 776 product categories going back to 1990. Given that even the two-country, two-good example is awkward to work out, what hope does the the two-country, two-good example is awkward to work out, what hope does the Ricardian model have of sorting out data of this complexity?Ricardian model have of sorting out data of this complexity?

In fact, a handful of developments have recently culminated in a formulation In fact, a handful of developments have recently culminated in a formulation of the Ricardian model that is highly amenable to exploiting exactly such data. of the Ricardian model that is highly amenable to exploiting exactly such data. This formulation has spawned a surge of studies to address various policy questions This formulation has spawned a surge of studies to address various policy questions quantitatively. We chart this evolution and show where it has led.quantitatively. We chart this evolution and show where it has led.

Ricardian Trade Theory: From Textbook Example to Practical Tool

To begin, let’s reformulate Ricardo’s example in terms of England’s wage To begin, let’s reformulate Ricardo’s example in terms of England’s wage ωω relative to Portugal’s, setting the Portuguese wage to 1. Making a unit of cloth in relative to Portugal’s, setting the Portuguese wage to 1. Making a unit of cloth in England will then cost 100England will then cost 100ωω, while making it in Portugal will cost 90. Making a unit , while making it in Portugal will cost 90. Making a unit of wine in England will cost 120of wine in England will cost 120ωω, while making it in Portugal will cost 80. With free , while making it in Portugal will cost 80. With free trade and perfect competition, the prices of cloth and of wine are the same in each trade and perfect competition, the prices of cloth and of wine are the same in each location and constitute the lowest-cost way of producing each good. Say that location and constitute the lowest-cost way of producing each good. Say that ωω is is bigger than 90/100, the ratio of Portuguese to English workers required to make bigger than 90/100, the ratio of Portuguese to English workers required to make cloth. Then, since cloth. Then, since

90 _ 100

> 80 _ 120

(cloth) (wine)

Table 1 Ricardo’s Example: How Many Workers to Make a Unit of a Good

Cloth Wine

England 100 120 Portugal 90 80

68 Journal of Economic Perspectives

both cloth and wine will be produced more cheaply in Portugal, leaving English labor out of work. Hence an English wage that is more than 90 percent of the Portuguese wage is not compatible with employment in England. At the other extreme, if ω is smaller than 80/120, then both cloth and wine will be cheaper if made in England, putting Portuguese labor out of work. Hence we need ω to be somewhere in between 2/3 and 9/10. (Because Ricardo granted Portugal an absolute advantage in both goods, he doomed English workers to a lower wage in order to be employed.) The idea that a Ricardian equilibrium involves identifying the source that can supply a good at minimum cost is at the heart of taking the model to more goods and countries.

Any hope of applying this example to actual world trade requires adding more Any hope of applying this example to actual world trade requires adding more goods and countries. How can we do that? Let’s proceed step by step.goods and countries. How can we do that? Let’s proceed step by step.

More Goods Let’s add another good, linen, while sticking with just our two countries. Say Let’s add another good, linen, while sticking with just our two countries. Say

England needs 100 workers to make a unit of linen, and Portugal needs 100 workers England needs 100 workers to make a unit of linen, and Portugal needs 100 workers as well. These numbers grant England an even stronger comparative advantage in as well. These numbers grant England an even stronger comparative advantage in linen than in cloth. We can extend the previous inequality to:linen than in cloth. We can extend the previous inequality to:

100 _ 100

> 90 _ 100

> 80 _ 120

.

(linen) (cloth) (wine)

This ordering of goods in terms of England’s relative productivity is called a chain of comparative advantage. Under free trade, the English relative wage ω breaks this chain between goods for which England’s relative productivity is above or below its relative wage. The goods to the left of the break are produced more cheaply in England and those to the right of the break are produced more cheaply in Portugal. For example, an ω of .95 breaks the chain between linen (produced more cheaply in England) and cloth and wine (cheaper from Portugal). An ω of .9 breaks it at cloth (costing the same from either country, with linen cheaper from England and wine cheaper from Portugal).

What determines the relative wage What determines the relative wage ωω that breaks the chain? In general, fi nding that breaks the chain? In general, fi nding it can be quite complicated but, if the two countries spend their income the same it can be quite complicated but, if the two countries spend their income the same way (specifi cally, if tastes are identical and homothetic), the problem simplifi es. We way (specifi cally, if tastes are identical and homothetic), the problem simplifi es. We can then use the chain of comparative advantage to construct the demand curve can then use the chain of comparative advantage to construct the demand curve for English labor relative to world labor (on the for English labor relative to world labor (on the x -axis) as it varies with the English -axis) as it varies with the English wage wage ωω (on the (on the y -axis).-axis).

If If ωω >> 1, then English labor has priced itself out of all goods. Hence, the demand 1, then English labor has priced itself out of all goods. Hence, the demand curve is just a vertical line at zero for curve is just a vertical line at zero for ωω above England’s relative productivity for above England’s relative productivity for good 1. At a wage good 1. At a wage ωω == 1, England is competitive in linen, and buyers are indifferent 1, England is competitive in linen, and buyers are indifferent between England and Portugal as a source. The demand curve for English labor is between England and Portugal as a source. The demand curve for English labor is then fl at (perfectly elastic) between zero and the point at which the demand for linen then fl at (perfectly elastic) between zero and the point at which the demand for linen is saturated at the price of 100. A decline in is saturated at the price of 100. A decline in ωω from this point renders England the from this point renders England the sole producer of linen. Since the price of linen is 100 sole producer of linen. Since the price of linen is 100 ωω, a drop in , a drop in ωω lowers the price lowers the price

Putting Ricardo to Work 69

of linen, increasing demand for it and hence for English labor. At the point of linen, increasing demand for it and hence for English labor. At the point ωω == .9, .9, England becomes competitive in cloth as well as linen. The demand curve for English England becomes competitive in cloth as well as linen. The demand curve for English labor thus hits another fl at zone as world buyers are indifferent between England and labor thus hits another fl at zone as world buyers are indifferent between England and Portugal as sources of cloth (continuing to buy all their linen from England and wine Portugal as sources of cloth (continuing to buy all their linen from England and wine from Portugal). Proceeding along the chain, the demand curve for English labor is from Portugal). Proceeding along the chain, the demand curve for English labor is a downward stairway with treads along which England and Portugal share produc-a downward stairway with treads along which England and Portugal share produc- tion of a good connected by risers along which England and Portugal specialize in tion of a good connected by risers along which England and Portugal specialize in producing distinct sets of goods. The treads are horizontal, as with a standard staircase, producing distinct sets of goods. The treads are horizontal, as with a standard staircase, but the risers are vertical only in an extreme case. Otherwise they slope downward to but the risers are vertical only in an extreme case. Otherwise they slope downward to the next tread. The equilibrium can be found by imposing the vertical supply curve the next tread. The equilibrium can be found by imposing the vertical supply curve for English labor as a share of the world’s, which could cut the demand curve along for English labor as a share of the world’s, which could cut the demand curve along a tread (corresponding to a good for which England and Portugal share production) a tread (corresponding to a good for which England and Portugal share production) or through a riser (with no shared goods).or through a riser (with no shared goods).

We count fi ve possible types of outcomes, going from linen, cloth, and wine We count fi ve possible types of outcomes, going from linen, cloth, and wine made in England and wine elsewhere, to linen, cloth, and wine made in Portugal made in England and wine elsewhere, to linen, cloth, and wine made in Portugal and linen elsewhere. Of course, more goods can be added by inserting them into and linen elsewhere. Of course, more goods can be added by inserting them into the chain, raising the number of types of outcomes.the chain, raising the number of types of outcomes.

Figure 1 illustrates the case for four goods, adding one product to the example Figure 1 illustrates the case for four goods, adding one product to the example above—say, anchovies—for which England requires twice as many workers as above—say, anchovies—for which England requires twice as many workers as

Figure 1 Wage Determination in the Many Good Model

Source: Authors. Note: The solid downward-sloping line is the relative demand curve for English labor, and the solid vertical line is the relative supply curve for English labor.

English share of world labor

E n

gl an

d’ s

re la

ti ve

w ag

e

1

1

9 10

2 3

1 2

L L+L*

ω

70 Journal of Economic Perspectives

Portugal to produce a unit. Changing the English labor supply involves sliding the Portugal to produce a unit. Changing the English labor supply involves sliding the English relative labor supply curve English relative labor supply curve L/(/(L ++ L**) along the ) along the x -axis where -axis where L is English is English labor and labor and L** Portugal’s. Portugal’s.

Trade economists now speak frequently of the extensive and intensive margins Trade economists now speak frequently of the extensive and intensive margins of trade. A country’s exports can increase on the intensive margin, exporting more of trade. A country’s exports can increase on the intensive margin, exporting more of a given set of goods, or on the extensive margin, exporting a wider range of of a given set of goods, or on the extensive margin, exporting a wider range of goods. The stairway shows how the two operate in a Ricardian framework. Along a goods. The stairway shows how the two operate in a Ricardian framework. Along a riser, a drop in riser, a drop in ωω raises demand for English exports only at the intensive margin, by raises demand for English exports only at the intensive margin, by lowering the price of the given set of goods that England produces. When lowering the price of the given set of goods that England produces. When ωω hits a hits a tread, however, expansion is also at the extensive margin as England expands the set tread, however, expansion is also at the extensive margin as England expands the set of goods it produces and exports.of goods it produces and exports.

An implication of the framework is that, given technologies around the world, An implication of the framework is that, given technologies around the world, having a larger share of the world labor force may require a country to have a lower having a larger share of the world labor force may require a country to have a lower wage. In order to employ more labor with its given set of technologies, a country wage. In order to employ more labor with its given set of technologies, a country needs to sell more of the goods it currently produces (going down a riser) or to needs to sell more of the goods it currently produces (going down a riser) or to take over goods from other countries (reaching a lower step). The result holds take over goods from other countries (reaching a lower step). The result holds

Figure 2 Wage Determination with a Continuum of Goods

Source: Authors. Notes: On the x -axis is a continuum of goods from 0 to 1 with England having the strongest comparative advantage in goods nearer 0 and Portugal in goods nearer 1. England produces the goods from 0 to

_ j .

Portugal produces the goods from _ j through 1. The fi gure illustrates how a shift up in the productivity

curve A( j ), meaning that England gets relatively more productive at making every good, raises England’s relative wage ω and expands the share of goods it produces. A partial derivation for the equation describing the upward-sloping curve is provided in footnote 2.

E n

gl an

d’ s

re la

ti ve

w ag

e

0 1

Goods produced in England Goods produced in Portugal

ω

ω′

A(j)

A(j)

j

‘j

jL*

(1 – j)L

Jonathan Eaton and Samuel Kortum 71

even though technologies are constant returns to scale, because larger size reduces even though technologies are constant returns to scale, because larger size reduces the gains from trade. This basic implication of the Ricardian model will survive its the gains from trade. This basic implication of the Ricardian model will survive its modern reincarnation.modern reincarnation.

While the construct is intuitive, stairways are trouble not only for wheeled While the construct is intuitive, stairways are trouble not only for wheeled vehicles but for comparative statics. Solving for the equilibrium is tedious.vehicles but for comparative statics. Solving for the equilibrium is tedious.

More Goods than You Can Count A classic paper by Dornbusch, Fischer, and Samuelson (1977) made life much A classic paper by Dornbusch, Fischer, and Samuelson (1977) made life much

simpler by replacing the stairway with a ramp. These authors had the insight that simpler by replacing the stairway with a ramp. These authors had the insight that inserting more and more goods into the chain of comparative advantage would inserting more and more goods into the chain of comparative advantage would render the gaps between the ratios of the labor requirements miniscule, in which render the gaps between the ratios of the labor requirements miniscule, in which case the three types of equilibria around any good in the original model collapse to case the three types of equilibria around any good in the original model collapse to the same outcome. They assumed that the set of goods correspond to all the points the same outcome. They assumed that the set of goods correspond to all the points on an interval between 0 and 1, and sorted the goods to form a chain of compara-on an interval between 0 and 1, and sorted the goods to form a chain of compara- tive advantage, with England having the strongest comparative advantage in goods tive advantage, with England having the strongest comparative advantage in goods closest to zero and Portugal in goods closest to one. They defi ned a function closest to zero and Portugal in goods closest to one. They defi ned a function A( ( j ) as ) as the ratio of Portugal’s labor requirements to England’s labor requirements for good the ratio of Portugal’s labor requirements to England’s labor requirements for good j, hence England’s relative productivity, for each , hence England’s relative productivity, for each j between 0 and 1. They went on to between 0 and 1. They went on to assume that assume that A( j ) was smooth and strictly decreasing. The downward sloping curve ) was smooth and strictly decreasing. The downward sloping curve in Figure 2 illustrates such a function. in Figure 2 illustrates such a function.

For any English wage For any English wage ωω between between A(0) and (0) and A(1) there is some good, let’s call it (1) there is some good, let’s call it __ j , satisfying A( , satisfying A(

__ j ) ) == ωω. This good . This good

__ j costs the same whether it is produced in England costs the same whether it is produced in England

or Portugal. England produces goods or Portugal. England produces goods j ≤≤ __ j , Portugal goods , Portugal goods j ≥≥

__ j . Who produces . Who produces

good good __ j is irrelevant to anything else, because this good is only an infi nitesimal frac-is irrelevant to anything else, because this good is only an infi nitesimal frac-

tion of the total. Because tion of the total. Because j goes from 0 to 1, goes from 0 to 1, __ j is also the share of goods produced is also the share of goods produced

in England, for consumption in either England or Portugal. Because in England, for consumption in either England or Portugal. Because A( ( j ) is ) is decreasing, a change that increases England’s relative wage decreasing, a change that increases England’s relative wage ωω, given the function , given the function A( ( j ), must reduce the share of goods produced in England.), must reduce the share of goods produced in England.

To fi gure out what To fi gure out what ωω will break the chain, we need to look at the demand side. will break the chain, we need to look at the demand side. A higher A higher

__ j means that England is producing a larger share of goods, increasing means that England is producing a larger share of goods, increasing

demand for its labor and hence its wage demand for its labor and hence its wage ωω. Figure 2 depicts this positive relationship . Figure 2 depicts this positive relationship between between ωω and and

__ j . Where it intersects the downward sloping . Where it intersects the downward sloping A( ( j ) curve determines ) curve determines

the equilibrium.the equilibrium.22

2 To get an exact expression for this upward-sloping relationship requires us to say something about tastes. The simplest assumption is that individuals in either country spread their spending evenly across the goods (as with symmetric Cobb–Douglas preferences). In this case the share of goods produced in England becomes the share of spending devoted to goods produced in England. Labor market equilib- rium requires full employment of workers in England and in Portugal at a relative wage ω, with English workers paid a fraction

_ j of world income, which is just the wage income in each country added together:

ωL = _ j (ωL + L*).

A lower English wage ω increases demand for English labor in two ways: At the intensive margin, a lower ω lowers the price of all goods England makes, so increases demand for them and thus for English workers. At the extensive margin, a lower ω increases the range of goods that England exports.

72 Journal of Economic Perspectives

Figure 2 illustrates how a shift up in the productivity curve Figure 2 illustrates how a shift up in the productivity curve A( ( j ), meaning that ), meaning that England gets relatively more productive at making every good, raises England’s rela-England gets relatively more productive at making every good, raises England’s rela- tive wage tive wage ωω and expands the share of goods it produces. and expands the share of goods it produces.

In all of the examples so far, if England and Portugal spend their incomes the In all of the examples so far, if England and Portugal spend their incomes the same way (again, meaning identical, homothetic preferences) there is no reason for same way (again, meaning identical, homothetic preferences) there is no reason for English and Portuguese to consume goods in different proportions. But a robust English and Portuguese to consume goods in different proportions. But a robust feature of data on trade and production is that countries tend to buy more goods feature of data on trade and production is that countries tend to buy more goods from themselves. We could explain this fact in terms of the basic Ricardian model from themselves. We could explain this fact in terms of the basic Ricardian model by assuming that Portuguese like wine more than the English. But it would be coin-by assuming that Portuguese like wine more than the English. But it would be coin- cidental if tastes always happened to align with comparative advantage, and there is cidental if tastes always happened to align with comparative advantage, and there is little evidence that they do.little evidence that they do.

A more plausible explanation is that moving goods between countries is costly. A more plausible explanation is that moving goods between countries is costly. Another useful contribution of Dornbusch, Fischer, and Samuelson (1977) is to Another useful contribution of Dornbusch, Fischer, and Samuelson (1977) is to introduce trade costs into their Ricardian model. Specifi cally, they make Samuelson’s introduce trade costs into their Ricardian model. Specifi cally, they make Samuelson’s classic iceberg assumption that delivering one unit of any good from one country classic iceberg assumption that delivering one unit of any good from one country to the other requires shipping to the other requires shipping d units, where units, where d ≥≥ 1. The specifi cation is consistent 1. The specifi cation is consistent with a fraction of the goods getting lost, rotten, or broken in shipment, but admits with a fraction of the goods getting lost, rotten, or broken in shipment, but admits many other interpretations as well.many other interpretations as well.

Because of iceberg trade barriers, goods no longer cost the same in each loca-Because of iceberg trade barriers, goods no longer cost the same in each loca- tion. Consider the case of cloth in Ricardo’s example. If the wage in England is tion. Consider the case of cloth in Ricardo’s example. If the wage in England is .8, then cloth costs 80 if made in England and 90 if made in Portugal. But say that .8, then cloth costs 80 if made in England and 90 if made in Portugal. But say that one-third of the cloth shipped from England to Portugal is ruined by saltwater in one-third of the cloth shipped from England to Portugal is ruined by saltwater in transport. Then 1.5 units of cloth need to be shipped to deliver 1 usable unit to transport. Then 1.5 units of cloth need to be shipped to deliver 1 usable unit to Portugal, raising the cost of English cloth in Portugal to 120. It no longer pays for Portugal, raising the cost of English cloth in Portugal to 120. It no longer pays for Portugal to import cloth from England rather than make it at home.Portugal to import cloth from England rather than make it at home.

What happens to the Dornbusch, Fischer, and Samuelson (1977) model if What happens to the Dornbusch, Fischer, and Samuelson (1977) model if we introduce a trade cost we introduce a trade cost d to all goods? The trade cost creates a range of goods to all goods? The trade cost creates a range of goods that are not traded as each country makes them more cheaply for itself. As long that are not traded as each country makes them more cheaply for itself. As long as as d is not too big, there is still a range of goods (with is not too big, there is still a range of goods (with j near zero) that England near zero) that England makes for everyone and another range (with makes for everyone and another range (with j near one) that Portugal makes near one) that Portugal makes for everyone.for everyone.

An important implication of the trade cost, which we exploit in our applications An important implication of the trade cost, which we exploit in our applications below, is that it introduces a relationship between any trade defi cit that England below, is that it introduces a relationship between any trade defi cit that England runs with Portugal and its relative wage. A transfer from England to Portugal diverts runs with Portugal and its relative wage. A transfer from England to Portugal diverts spending away from the nontraded goods that England was producing for itself spending away from the nontraded goods that England was producing for itself toward the production of those same goods in Portugal. As a consequence, the toward the production of those same goods in Portugal. As a consequence, the English wage falls, leading to an expansion of the range of goods that England English wage falls, leading to an expansion of the range of goods that England exports and a contraction of the range that Portugal exports.exports and a contraction of the range that Portugal exports.

The work of Dornbusch, Fischer, and Samuelson (1977) moved the Ricardian The work of Dornbusch, Fischer, and Samuelson (1977) moved the Ricardian framework far forward from being a toy example to becoming a tool that can address framework far forward from being a toy example to becoming a tool that can address a variety of questions. For example, Matsuyama (2008) uses variants of the model to a variety of questions. For example, Matsuyama (2008) uses variants of the model to examine the consequences of country size, technological change, and technology examine the consequences of country size, technological change, and technology transfer on the gains from trade and the distribution of income. But a limitation transfer on the gains from trade and the distribution of income. But a limitation remains. There are still only two countries.remains. There are still only two countries.

Putting Ricardo to Work 73

More Countries It’s just as straightforward to add more countries to Ricardo’s example as more It’s just as straightforward to add more countries to Ricardo’s example as more

goods. Let’s add a third country, France, with labor requirements 120 in cloth and goods. Let’s add a third country, France, with labor requirements 120 in cloth and 60 in wine. Begin by rewriting Ricardo’s earlier inequality as60 in wine. Begin by rewriting Ricardo’s earlier inequality as

120 _ 100

> 80 _ 90

(England) (Portugal)

and then insert France into the chain to get:

120 _ 100

> 80 _ 90

> 60 _ 120

.

(England) (Portugal) (France)

England, at one end of the chain, will produce cloth and France, at the other end, will produce wine. As before, tastes and the sizes of the labor forces in each country will determine where the chain is broken. As above, we count fi ve types of possible outcomes. We are back to a stairway. More countries can be added, but the number of cases expands. As with two countries and many goods, fi nding the solution is relatively straightforward but tedious.

The Challenge: Many Goods with Many Countries What about more goods What about more goods and more countries? In this setting, chains no longer more countries? In this setting, chains no longer

work. Jones (1961) provides an example with the following labor requirements for work. Jones (1961) provides an example with the following labor requirements for three countries in three goods: three countries in three goods:

America Britain Europe

Corn 10 10 10 Linen 5 7 3 . Cloth 4 3 2

Two assignments—(America, Linen; Britain, Corn; Europe, Cloth) and (America, Corn; Britain, Cloth; Europe, Linen)—each satisfy Ricardo’s inequality for any two countries and any two goods looked at in isolation from the third.3 But only the

3 Graham (1948) solved for competitive equilibria in numerical examples of the Ricardian model with many countries and many goods. His generalizations from these examples were not always correct. McKenzie (1954) formalized Graham’s model and used it in his demonstration of the existence and uniqueness of a competitive equilibrium. In this journal, Weintraub (2011) provides a detailed account of McKenzie’s relatively unheralded contribution. McKenzie (1953) established the equivalence between an effi cient solution and a competitive equilibrium in Graham’s model, and pointed to the inadequacy of bilateral comparisons in determining effi cient specialization. The contribution of Jones (1961) is to obtain a simple characterization of effi cient specialization in this model.

74 Journal of Economic Perspectives

second is a possible competitive equilibrium. To see why, cross multiply Ricardo’s earlier inequality so that it appears a third way as:

120 × 90 > 100 × 80 . incorrect(assignment) correct(assignment)

Note that England producing cloth and Portugal wine, the equilibrium assignment in Ricardo’s example, minimizes the product of the labor requirements for the tech- nologies used. Generalizing this result, Jones can rule out the fi rst assignment in his example since it involves a higher value for the product of the labor requirements used (5 × 10 × 2 = 100 versus 10 × 3 × 3 = 90).4

Fun as this example is, it doesn’t provide much guidance into how to solve for Fun as this example is, it doesn’t provide much guidance into how to solve for the equilibrium in high-dimensional cases. For one thing, we’re still left with the the equilibrium in high-dimensional cases. For one thing, we’re still left with the problem of fi guring out if the solution is on a tread or a riser. But now we have stair-problem of fi guring out if the solution is on a tread or a riser. But now we have stair- ways running in multiple directions in ways that only M. C. Escher could diagram.ways running in multiple directions in ways that only M. C. Escher could diagram.

A Solution: Distributions of Worker Requirements Again, we need a ramp. To construct one, let’s return to the Dornbusch, Fischer, Again, we need a ramp. To construct one, let’s return to the Dornbusch, Fischer,

and Samuelson (1977) formulation with a continuum of goods, but now allow for and Samuelson (1977) formulation with a continuum of goods, but now allow for an arbitrary (integer) number an arbitrary (integer) number I of countries. We must deal with unit labor require- of countries. We must deal with unit labor require- ments for each good (one for each point on the unit interval) in each country (of ments for each good (one for each point on the unit interval) in each country (of which there are which there are I ), vastly more numbers than Ricardo’s four.), vastly more numbers than Ricardo’s four.

To tackle the problem, let’s fi rst give up on actual numbers and, following To tackle the problem, let’s fi rst give up on actual numbers and, following Dornbusch, Samuelson, and Fisher (1977), label the labor requirement for good Dornbusch, Samuelson, and Fisher (1977), label the labor requirement for good j in in countrycountry i by by aii( ( j ). With ). With I >> 2 countries and lots of goods, it doesn’t help to think about 2 countries and lots of goods, it doesn’t help to think about ratios of the ratios of the a’s, so chains are out of the question. Instead, we will think about the ’s, so chains are out of the question. Instead, we will think about the a’s ’s as the realizations of random variables drawn from a particular family of probability as the realizations of random variables drawn from a particular family of probability

4 This idea generalizes to the I-good, I-country case. To see why this rule works it helps to go back to prices and to think about fi nding the minimum cost source. Let’s index countries by i = 1, . . . , I and goods by j = 1, . . . , I and denote the amount of labor needed to make good j in country i as ai( j ). Let wi be the wage in country i and p( j ) the world price of good j (as there are no transport costs). Let’s also number countries and goods so good j is produced by country i = j in an effi cient outcome (so that we can label by j the country producing good j under the correct assignment). Perfect competition then means that p( j ) = aj( j )wj (zero profi ts where good j is produced) and p( j ) ≤ ai( j )wi for all other countries i (no profi t opportunities anywhere else). Multiplying the equalities together for the correct assignment gives:

∏ j =1

I

p( j ) = ∏ j =1

I

aj( j ) ∏ j =1

I

wj .

Multiplying together the inequalities for any other one-to-one assignment i(j) of country i to good j gives:

∏ j =1

I

p( j ) ≤ ∏ j =1

I

[ ai( j )( j )wi( j )] = ∏ j =1

I

ai( j ) ( j ) ∏ j =1

I

wi( j ) .

Since the terms ∏ j=1 I p( j ) and ∏ j=1

I wi( j ) = ∏ j=1

I wj are the same in each, the only way both expressions

can be true is if

∏ j =1

I

aj( j ) ≤ ∏ j =1

I

a i( j )( j ).

Jonathan Eaton and Samuel Kortum 75

distributions. This way of thinking about technology (the labor requirements to distributions. This way of thinking about technology (the labor requirements to produce different goods in different locations) has two advantages: First, the distribu-produce different goods in different locations) has two advantages: First, the distribu- tions themselves can be smooth, giving us our ramp. Second, we don’t have to keep tions themselves can be smooth, giving us our ramp. Second, we don’t have to keep track of all the individual track of all the individual aii( ( j )’s, of which there are many, but only the parameters of )’s, of which there are many, but only the parameters of the distributions from which they are drawn, which can be small in number.the distributions from which they are drawn, which can be small in number.

Before getting into the details, it’s useful to step back and articulate some Before getting into the details, it’s useful to step back and articulate some principles that guide the choice of a family of distributions. First, we want to stay principles that guide the choice of a family of distributions. First, we want to stay within the family when we move from the distribution of labor requirements to within the family when we move from the distribution of labor requirements to the distribution of the costs of producing goods. Second, we want to stay within the distribution of the costs of producing goods. Second, we want to stay within the family when we consider the distribution of the price of a good in a country, the family when we consider the distribution of the price of a good in a country, which is the minimum of the cost of acquiring it across all potential source countries. which is the minimum of the cost of acquiring it across all potential source countries. Finally, we want a simple expression for the probability that a particular country is Finally, we want a simple expression for the probability that a particular country is the low-cost source.the low-cost source.

These considerations led us, in Eaton and Kortum (2002), to a family of what These considerations led us, in Eaton and Kortum (2002), to a family of what are called extreme-value distributions. The well-known central limit theorem states are called extreme-value distributions. The well-known central limit theorem states that if a large sample is taken from a well-behaved distribution, then the mean of the that if a large sample is taken from a well-behaved distribution, then the mean of the sample has an approximate normal distribution. Less well-known is that the highest sample has an approximate normal distribution. Less well-known is that the highest or lowest observations in such a sample also can approach a particular distribution, or lowest observations in such a sample also can approach a particular distribution, called an extreme-value distribution. For example, consider the winning (fastest) called an extreme-value distribution. For example, consider the winning (fastest) times in a series of races. If each runner’s time is drawn from a particular distribu-times in a series of races. If each runner’s time is drawn from a particular distribu- tion, such as the lognormal, then the fastest time across a large number of races has tion, such as the lognormal, then the fastest time across a large number of races has an extreme value distribution, which, if the times are lognormal, turns out to be the an extreme value distribution, which, if the times are lognormal, turns out to be the type-III extreme value, or Weibull distribution.type-III extreme value, or Weibull distribution.

What’s the connection between winning a race and the number of workers What’s the connection between winning a race and the number of workers needed to make a product? As derived in Kortum (1997) and Eaton and Kortum needed to make a product? As derived in Kortum (1997) and Eaton and Kortum (1999), if technologies for making a good are the results of inventions that occur (1999), if technologies for making a good are the results of inventions that occur over time, and if the output per worker delivered by an invention is drawn from over time, and if the output per worker delivered by an invention is drawn from the Pareto distribution, then output per worker using the most effi cient (that is, the Pareto distribution, then output per worker using the most effi cient (that is, winning) technology discovered to date have a type-II or Fréchet distribution.winning) technology discovered to date have a type-II or Fréchet distribution.

The Ricardian language describes a technology by its worker requirement The Ricardian language describes a technology by its worker requirement rather than by its reciprocal, output per worker. Translating our results on the rather than by its reciprocal, output per worker. Translating our results on the Fréchet distribution above into Ricardian, the probability that the labor require-Fréchet distribution above into Ricardian, the probability that the labor require- ment for producing any particular good ment for producing any particular good j in country in country i is less than any positive is less than any positive number number x forms a Weibull distribution, specifi cally: forms a Weibull distribution, specifi cally:

Pr[ai( j ) ≤ x] = 1 – e –( A i x )

θ .

Its two parameters relate to absolute and comparative advantage. The parameter Ai captures country i’s absolute advantage: A higher value means that the labor requirement is likely to be lower for any good. Having absolute advantage vary across countries allows us to capture the fact that some countries are much more productive than others across a wide range of activities: for example, in the way Portugal is more productive than England across both goods in Ricardo’s example. A country that has accumulated more technology will have a higher Ai .

76 Journal of Economic Perspectives

The parameter The parameter θθ captures (inversely) how variable the labor requirement is, captures (inversely) how variable the labor requirement is, with a higher value meaning that a country’s labor requirement is typically close with a higher value meaning that a country’s labor requirement is typically close to its mean, weakening the force of comparative advantage. In Ricardo’s example to its mean, weakening the force of comparative advantage. In Ricardo’s example above, suppose Portugal could make cloth with 67 workers rather than with 90. above, suppose Portugal could make cloth with 67 workers rather than with 90. While Portugal would still be better at both goods than England, it’s no longer While Portugal would still be better at both goods than England, it’s no longer differentially much better at wine. As Ricardo’s inequality gets closer to equality, differentially much better at wine. As Ricardo’s inequality gets closer to equality, the scope for gains from trade decreases. Similarly, a high value of the scope for gains from trade decreases. Similarly, a high value of θθ in our model in our model reduces the gains from trade. Imposing a common reduces the gains from trade. Imposing a common θθ across countries makes it easy across countries makes it easy for us to see how technologies around the world interact through trade.for us to see how technologies around the world interact through trade.

The extreme value distribution is convenient, but how well does it refl ect reality? The extreme value distribution is convenient, but how well does it refl ect reality? As described above, a way of generating this distribution is to draw worker effi cien-As described above, a way of generating this distribution is to draw worker effi cien- cies repeatedly from a Pareto distribution, taking the largest. The upper tail of the cies repeatedly from a Pareto distribution, taking the largest. The upper tail of the distribution, representing the most effi cient fi rms, itself resembles a Pareto distribu-distribution, representing the most effi cient fi rms, itself resembles a Pareto distribu- tion. Wilfredo Pareto invented what we now call the Pareto distribution to describe tion. Wilfredo Pareto invented what we now call the Pareto distribution to describe how income was distributed. It turns out that the Pareto distribution, sometimes how income was distributed. It turns out that the Pareto distribution, sometimes called a “power law,” describes the upper tail of a large number of magnitudes, such called a “power law,” describes the upper tail of a large number of magnitudes, such as city population and fi rm sales and employment. Hence the extreme value distribu-as city population and fi rm sales and employment. Hence the extreme value distribu- tion fi ts the data quite well.tion fi ts the data quite well.

Since we now have Since we now have I countries, iceberg trade costs can now vary with the pair countries, iceberg trade costs can now vary with the pair of countries in question, so that delivering a unit of a good to country of countries in question, so that delivering a unit of a good to country n requires requires shipping shipping dnini ≥≥ 1 units from country 1 units from country i (with (with diiii == 1). These trade costs can capture 1). These trade costs can capture a well-known regularity in data on trade, which is that the amount of trade between a well-known regularity in data on trade, which is that the amount of trade between two countries tends to fall as the distance between them rises. This feature is two countries tends to fall as the distance between them rises. This feature is known as “gravity,” and gravity models of trade build on this insight. The multi-known as “gravity,” and gravity models of trade build on this insight. The multi- country framework developed here will display gravity if iceberg costs between any country framework developed here will display gravity if iceberg costs between any two countries rise systematically with the distance between them. Here, although we two countries rise systematically with the distance between them. Here, although we incorporate iceberg costs, we steer away from giving them too specifi c an interpreta-incorporate iceberg costs, we steer away from giving them too specifi c an interpreta- tion. The issue of how well iceberg costs capture reality remains subject to debate: tion. The issue of how well iceberg costs capture reality remains subject to debate: see Anderson and van Wincoop (2004) for further discussion.see Anderson and van Wincoop (2004) for further discussion.

Putting all these ingredients together, the cost of producing a good Putting all these ingredients together, the cost of producing a good j in in country country i and delivering it to country and delivering it to country n is is cnini( ( j ) ) == aii( ( j ))wii dnini , the product of the , the product of the labor requirement in country labor requirement in country i, the wage in , the wage in i, and the iceberg cost of moving , and the iceberg cost of moving goods from goods from i to to n. As in Dornbusch, Fischer, and Samuelson (1977), wages and . As in Dornbusch, Fischer, and Samuelson (1977), wages and trade costs are the same for all goods produced in a country, and so trade costs are the same for all goods produced in a country, and so cnini( ( j ) has the ) has the same distribution as same distribution as aii( ( j ), only with the absolute advantage parameter ), only with the absolute advantage parameter Ai i replaced replaced by by Anini == Aii /( /(wii dnini ). The positive effect of raw effi ciency in country ). The positive effect of raw effi ciency in country i (through a (through a higher higher Aii) on the cost distribution in ) on the cost distribution in n is offset by a higher wage and a higher cost is offset by a higher wage and a higher cost of shipping to country of shipping to country n..

Just as in the basic Ricardian model, perfect competition guarantees that the Just as in the basic Ricardian model, perfect competition guarantees that the price price pnn( ( j ) of good ) of good j in country in country n is the lowest cost is the lowest cost cnini( ( j ) looking across all potential ) looking across all potential sources sources i. Unlike the simple Ricardian model with no trade costs, in the more general . Unlike the simple Ricardian model with no trade costs, in the more general set-up here, which country set-up here, which country I provides the good at lowest cost may differ across desti- provides the good at lowest cost may differ across desti- nations nations n. We already saw such an outcome in the two-country Dornbusch, Fischer, . We already saw such an outcome in the two-country Dornbusch, Fischer, and Samuelson (1977) model with trade costs: Each country produced a range of and Samuelson (1977) model with trade costs: Each country produced a range of

Putting Ricardo to Work 77

goods for itself while other goods, for which differences in productivity were more goods for itself while other goods, for which differences in productivity were more extreme, were produced in only one country. While the multicountry formulation extreme, were produced in only one country. While the multicountry formulation here is more complicated, the distribution of the price of a good here is more complicated, the distribution of the price of a good j in country in country n is straightforward. It inherits the extreme value distribution from the costs is straightforward. It inherits the extreme value distribution from the costs cnini( ( j ) ) of which of which pnn( ( j ) is the minimum across all potential sources ) is the minimum across all potential sources I, with its distribution , with its distribution remaining in the Weibull family.remaining in the Weibull family.55

Aside from telling us about prices, the model can also tell us about trade Aside from telling us about prices, the model can also tell us about trade between any two countries via the probability between any two countries via the probability ππnini that a particular country that a particular country i is the is the lowest cost source of a good in country lowest cost source of a good in country n. This probability is lower the higher . This probability is lower the higher dnini , , the trade barrier in shipping from the trade barrier in shipping from i to to n, and the higher the wage in the source , and the higher the wage in the source country, adjusted for absolute advantage. Since there are a continuum of goods, country, adjusted for absolute advantage. Since there are a continuum of goods, the probability the probability ππnini is also the share of goods in country is also the share of goods in country n supplied by country supplied by country i. . Furthermore, with symmetric Cobb–Douglas preferences, the Furthermore, with symmetric Cobb–Douglas preferences, the ππnini’s also correspond ’s also correspond to the fraction of country to the fraction of country n’s spending devoted to goods bought from country ’s spending devoted to goods bought from country i. . These purchases are imports if These purchases are imports if i and and n are different, but are domestic sales when are different, but are domestic sales when i and and n are the same. are the same.66 Because data on the value of trade and production are Because data on the value of trade and production are readily available to calculate trade shares, the readily available to calculate trade shares, the ππnini’s provide a crucial link between ’s provide a crucial link between the model and data.the model and data.

Anything that lowers a country’s cost of serving a market (such as a lower tariff) Anything that lowers a country’s cost of serving a market (such as a lower tariff) means more purchases are shifted there; how much depends on means more purchases are shifted there; how much depends on θθ. Remember that . Remember that a larger a larger θθ means that technologies are more similar across goods from any given means that technologies are more similar across goods from any given country. Hence a given change in costs implies a bigger shift in trade shares when country. Hence a given change in costs implies a bigger shift in trade shares when θθ is high, since relative costs don’t vary that much across countries.is high, since relative costs don’t vary that much across countries.

Trade economists have long sought to measure the elasticity of trade with respect Trade economists have long sought to measure the elasticity of trade with respect to relative costs, which are affected by such things as changes in tariffs or exchange to relative costs, which are affected by such things as changes in tariffs or exchange rates. In our analysis, rates. In our analysis, θθ determines that elasticity. It plays an important role in all determines that elasticity. It plays an important role in all that follows. In our numerical analysis below, we use a value of that follows. In our numerical analysis below, we use a value of θθ == 4 suggested in a 4 suggested in a recent paper by Simonovska and Waugh (2011). Their recommended value is based recent paper by Simonovska and Waugh (2011). Their recommended value is based on a careful analysis of the prices of 62 manufactured goods across 123 countries, on a careful analysis of the prices of 62 manufactured goods across 123 countries, and the estimate is in line with several earlier studies based on other evidence.and the estimate is in line with several earlier studies based on other evidence.

How does trade translate into welfare in this framework? The model delivers How does trade translate into welfare in this framework? The model delivers a handy expression for the real wage in country a handy expression for the real wage in country I, which is proportional to , which is proportional to Aii π π ii

–1/–1/θθ . .

5 In particular, the distribution of prices pn( j ) emerges just by replacing Ai in the distribution of labor requirements with a term

_ A n , that aggregates the Ani’s from each source i:

( _ A n)

θθ = ∑ i=1

I

( Ani) θθ.

The expression for _ A n shows how higher effi ciency, lower wages, and greater proximity of country n’s

trading partners translates into lower prices. 6 The trade share turns out to be country i’s contribution to the term

_ A n given in the previous footnote:

ππnini == (Ani/ _ A n)θθ. With Cobb–Douglas preferences, the ideal price index pn in country n is the geometric

mean of the price distribution, which is simply γ/ _ A n . The constant γ is given as equation (5) in the online

appendix available with this paper at ⟨http://e-jep.org⟩. We could be much more general in our specifi – cation of preferences, but for our analysis here nothing would be gained. For example, with Dixit–Stiglitz preferences, the only change is in the formula for γ, which then depends on the elasticity of substitution.

78 Journal of Economic Perspectives

The absolute advantage parameter The absolute advantage parameter Aii captures labor productivity in the country. In captures labor productivity in the country. In a closed economy, with a closed economy, with ππiiii == 1, productivity by itself determines the real wage. The 1, productivity by itself determines the real wage. The second term second term π π ii

–1/–1/θθ captures the gains from trade. captures the gains from trade.77 A country A country i with a small home with a small home share share ππiiii makes use (via imports) of technologies from elsewhere for a large range of makes use (via imports) of technologies from elsewhere for a large range of goods. Without trade, of course, it would be using its own technologies to make these goods. Without trade, of course, it would be using its own technologies to make these goods. How much a given drop in the home share in moving from autarky to trade goods. How much a given drop in the home share in moving from autarky to trade raises welfare depends on how different the technologies embodied in imports are raises welfare depends on how different the technologies embodied in imports are from the domestic technologies they replace. The smaller is from the domestic technologies they replace. The smaller is θθ, the bigger the differ-, the bigger the differ- ence, on average, and hence the larger the gains. Hence a country without many ence, on average, and hence the larger the gains. Hence a country without many advanced technologies itself may nevertheless have a high living standard because advanced technologies itself may nevertheless have a high living standard because it specializes in the technologies in which it is most advanced and purchases the it specializes in the technologies in which it is most advanced and purchases the rest from abroad. Using our value of rest from abroad. Using our value of θθ == 4, we can infer that a country importing 4, we can infer that a country importing 25 percent of what it consumes from abroad, hence purchasing 75 percent locally, 25 percent of what it consumes from abroad, hence purchasing 75 percent locally, gains about 7.5 percent in real income.gains about 7.5 percent in real income.

While it’s very useful to infer the gains from trade by knowing just the home While it’s very useful to infer the gains from trade by knowing just the home share in expenditure and the parameter share in expenditure and the parameter θθ, the home share itself depends on wages , the home share itself depends on wages around the world, which are determined by the labor market equilibrium in each around the world, which are determined by the labor market equilibrium in each country. In order to solve for wages, we need to know not only the trade costs but country. In order to solve for wages, we need to know not only the trade costs but the labor endowment the labor endowment Lii in each country and the trade defi cit in each country and the trade defi cit Dii each country runs each country runs with the rest of the world.with the rest of the world.

In general, we can’t solve the system of labor market equilibrium conditions for In general, we can’t solve the system of labor market equilibrium conditions for wages analytically, although a computer can spit out the answers rapidly, even with wages analytically, although a computer can spit out the answers rapidly, even with several hundred countries. But with costless trade (that is, no iceberg costs), we can several hundred countries. But with costless trade (that is, no iceberg costs), we can obtain an analytic solution. In this special case, the relative wage between two coun-obtain an analytic solution. In this special case, the relative wage between two coun- tries is increasing in the ratio of their productivities (their tries is increasing in the ratio of their productivities (their Aii’s), with an elasticity of s), with an elasticity of θθ/(1 /(1 ++ θθ). That this elasticity is below one refl ects the fact that in an open economy ). That this elasticity is below one refl ects the fact that in an open economy a country passes on some of the benefi ts of its own higher productivity to others a country passes on some of the benefi ts of its own higher productivity to others through lower export prices. In this way, even without international technology through lower export prices. In this way, even without international technology diffusion, international trade allows countries to benefi t from having trading part-diffusion, international trade allows countries to benefi t from having trading part- ners with a high level of technology. The relative wage is decreasing in the ratio of ners with a high level of technology. The relative wage is decreasing in the ratio of labor endowments (the labor endowments (the Lii’s), with an elasticity of –1/(1 s), with an elasticity of –1/(1 ++ θθ). This elasticity is nega-). This elasticity is nega- tive, just as in the basic Ricardian model. A country with more workers, in order to tive, just as in the basic Ricardian model. A country with more workers, in order to employ them, produces more of an existing set of goods (the intensive margin), employ them, produces more of an existing set of goods (the intensive margin), lowering their relative price. Here, in addition, the country diversifi es into addi-lowering their relative price. Here, in addition, the country diversifi es into addi- tional goods (expanding at the extensive margin) in which its relative productivity tional goods (expanding at the extensive margin) in which its relative productivity is lower. Without trade barriers, the relative wage is independent of trade defi cits, is lower. Without trade barriers, the relative wage is independent of trade defi cits, just as defi cits don’t matter for wages in Dornbusch, Fischer, and Samuelson (1977) just as defi cits don’t matter for wages in Dornbusch, Fischer, and Samuelson (1977) when there are no trade costs.when there are no trade costs.

In a world of costless trade, we can see how countries’ endowments of labor and In a world of costless trade, we can see how countries’ endowments of labor and technology interact to determine their relative welfare. Recognizing that distance technology interact to determine their relative welfare. Recognizing that distance matters introduces location as a third major determinant of a country’s relative matters introduces location as a third major determinant of a country’s relative

7 Arkolakis, Costinot, and Rodríguez-Clare (2012) show how, with θ suitably reinterpreted, this result on the gains from trade generalizes to a wide class of models.

Jonathan Eaton and Samuel Kortum 79

income and welfare. Proximity to large markets and to inexpensive sources of goods income and welfare. Proximity to large markets and to inexpensive sources of goods then becomes another important feature of a country in determining its welfare.then becomes another important feature of a country in determining its welfare.

To get some sense of the magnitude of geography’s role in a country’s well-being To get some sense of the magnitude of geography’s role in a country’s well-being let’s perform a numerical exercise with just two countries. Say that one country is let’s perform a numerical exercise with just two countries. Say that one country is large, with 99 percent of the world’s labor, and the other small, with 1 percent of large, with 99 percent of the world’s labor, and the other small, with 1 percent of the world’s labor. Let’s start by assuming free trade and labor effi ciencies such that the world’s labor. Let’s start by assuming free trade and labor effi ciencies such that with no trade barriers the two countries have the same wage (and hence the same with no trade barriers the two countries have the same wage (and hence the same real wage since prices are the same). In a frictionless world with no trade barriers, real wage since prices are the same). In a frictionless world with no trade barriers, the small country would spend only 1 percent of its income on goods from itself.the small country would spend only 1 percent of its income on goods from itself.

Now imagine introducing a trade barrier between the two countries, so that Now imagine introducing a trade barrier between the two countries, so that the iceberg costs are the iceberg costs are d == 2 for sending goods in either direction. In the resulting 2 for sending goods in either direction. In the resulting equilibrium, the small country spends just under half of its income on goods from equilibrium, the small country spends just under half of its income on goods from itself (a typical amount for an actual small country). While the large country is virtu-itself (a typical amount for an actual small country). While the large country is virtu- ally unaffected by the change, the real wage in the small country falls to 38 percent ally unaffected by the change, the real wage in the small country falls to 38 percent of that in the large country. This decline is the result of two effects. First, to be of that in the large country. This decline is the result of two effects. First, to be competitive in the large country, the small country’s wage has to fall to 65 percent of competitive in the large country, the small country’s wage has to fall to 65 percent of the large country’s wage. Second, because goods from the large country are expen-the large country’s wage. Second, because goods from the large country are expen- sive to import, the price index is 70 percent higher.sive to import, the price index is 70 percent higher.

With these trade barriers in place, how much of a productivity boost would we With these trade barriers in place, how much of a productivity boost would we have to give the small country to bring its real wage back up to the level in the rich have to give the small country to bring its real wage back up to the level in the rich one? The answer is so much that under costless trade its wage would be more than one? The answer is so much that under costless trade its wage would be more than double the large country’s. An implication of this example is that, by infl uencing double the large country’s. An implication of this example is that, by infl uencing trade costs, geography can play as important a role in determining income differ-trade costs, geography can play as important a role in determining income differ- ences as technology.ences as technology.

Applying the Tool

Having shown how the Ricardian model can accommodate a complex world Having shown how the Ricardian model can accommodate a complex world of many goods and many countries separated by trade barriers, we now connect it of many goods and many countries separated by trade barriers, we now connect it to data. We can then use it to ask many questions both about the world as it is and to data. We can then use it to ask many questions both about the world as it is and what it would look like under different circumstances. In this section, we investi-what it would look like under different circumstances. In this section, we investi- gate four particular questions: 1) How much do countries gain from trade, and gate four particular questions: 1) How much do countries gain from trade, and how have these gains evolved over the last two decades? 2) How much will these how have these gains evolved over the last two decades? 2) How much will these gains grow if falling trade costs lead to further increases in world trade? 3) To what gains grow if falling trade costs lead to further increases in world trade? 3) To what extent do countries benefi t from the technological improvements of their trading extent do countries benefi t from the technological improvements of their trading partners? 4) What are the costs to defi cit countries of moving to balanced trade?partners? 4) What are the costs to defi cit countries of moving to balanced trade?

We fi t the model to data on 32 countries (31 actual countries and a “rest of We fi t the model to data on 32 countries (31 actual countries and a “rest of the world” which combines all the others) as listed later in Table 3. The limit on the world” which combines all the others) as listed later in Table 3. The limit on the number of countries arises from the availability of data; adding countries adds the number of countries arises from the availability of data; adding countries adds little to computational complexity.little to computational complexity.

While any model is a simplifi cation, we can bring the model we have been While any model is a simplifi cation, we can bring the model we have been discussing here much closer to reality with three embellishments: First, the model discussing here much closer to reality with three embellishments: First, the model applies quite naturally to manufactures, the dominant component of trade for most applies quite naturally to manufactures, the dominant component of trade for most

80 Journal of Economic Perspectives

high-income countries. Indeed, manufactures make up 64 percent of trade in goods high-income countries. Indeed, manufactures make up 64 percent of trade in goods and services among our 31 actual countries. It is less clear how well this model and services among our 31 actual countries. It is less clear how well this model applies to services or to products in which natural resources play a major role. To applies to services or to products in which natural resources play a major role. To focus on trade in manufactures, we follow Alvarez and Lucas (2007) and divide the focus on trade in manufactures, we follow Alvarez and Lucas (2007) and divide the economy into two sectors, which we call manufacturing and services, with labor economy into two sectors, which we call manufacturing and services, with labor mobile between them. Among our set of countries, manufactures represent only a mobile between them. Among our set of countries, manufactures represent only a share share αα of about 0.2 of fi nal spending. of about 0.2 of fi nal spending.

Second, while manufactures are not a large share of fi nal spending, a great deal Second, while manufactures are not a large share of fi nal spending, a great deal of manufacturing output goes into the production of manufactures. Among our coun-of manufacturing output goes into the production of manufactures. Among our coun- tries, the share tries, the share ββ of labor in manufacturing production is only about 0.3 with most of of labor in manufacturing production is only about 0.3 with most of the rest manufactured intermediates. As pointed out, for example, by Krugman and the rest manufactured intermediates. As pointed out, for example, by Krugman and Venables (1995), recognizing the importance of manufactures as inputs makes loca-Venables (1995), recognizing the importance of manufactures as inputs makes loca- tion as well as geography an important determinant of manufacturing costs. In Dekle, tion as well as geography an important determinant of manufacturing costs. In Dekle, Eaton, and Kortum (2007), we describe in more detail how we set Eaton, and Kortum (2007), we describe in more detail how we set αα and and ββ..

Third, the textbook Ricardian model typically assumes that trade is balanced. Third, the textbook Ricardian model typically assumes that trade is balanced. However, we design our model to accommodate defi cits both in manufacturing and However, we design our model to accommodate defi cits both in manufacturing and in everything else. In fact, one of our exercises is to examine the consequence of in everything else. In fact, one of our exercises is to examine the consequence of shifting these defi cits in order to balance each country’s current account. To fi nish shifting these defi cits in order to balance each country’s current account. To fi nish putting numbers on the model we go to the OECD STAN (STructural ANalysis) putting numbers on the model we go to the OECD STAN (STructural ANalysis) Database for data on bilateral trade and production of manufactures and to the Database for data on bilateral trade and production of manufactures and to the Economist Intelligence Unit for data on unilateral trade in goods and services, GDP, Economist Intelligence Unit for data on unilateral trade in goods and services, GDP, and the current account. Along with our values for the three parameters and the current account. Along with our values for the three parameters θθ == 4, 4, αα == 0.2, and 0.2, and ββ == 0.3, these data tell us all that we need to know about the rest of 0.3, these data tell us all that we need to know about the rest of parameters in order to answer our four questions. We can answer our fi rst question, parameters in order to answer our four questions. We can answer our fi rst question, about the magnitude of gains from trade, directly from data by using a relationship about the magnitude of gains from trade, directly from data by using a relationship discussed in the previous section. The other three questions force us to consider all discussed in the previous section. The other three questions force us to consider all of the shifts in wages and prices around the world that would result from a change of the shifts in wages and prices around the world that would result from a change in trade costs, technology, or trade defi cits.in trade costs, technology, or trade defi cits.

We calculate counterfactuals in the following way: We shock the model by changing We calculate counterfactuals in the following way: We shock the model by changing the relevant parameters. We denote the new level of a variable or parameter the relevant parameters. We denote the new level of a variable or parameter x as as x ′′ and and the proportional change in it as the proportional change in it as ̂̂ x == x ′′//x. In particular, we consider changes . In particular, we consider changes ̂̂

d nini in trade in trade

costs (keeping them at one when costs (keeping them at one when i == n), changes ), changes ̂̂ A ii in technology, or counterfactual in technology, or counterfactual defi cits defi cits D n ′′ (and (and D i

M ′′ for manufactures). We then calculate the changes in wages for manufactures). We then calculate the changes in wages ̂̂ w ii and and prices prices ̂̂ p ii needed to re-equilibrate the world economy. Our baseline is the world as it was needed to re-equilibrate the world economy. Our baseline is the world as it was in 2009, the last year for which data are available for all of our countries.in 2009, the last year for which data are available for all of our countries.

Gains from Trade As discussed above, we can measure the gains from trade using data on only the As discussed above, we can measure the gains from trade using data on only the

home share, home share, ππiiii . For this exercise we employ a direct measure of the home share: . For this exercise we employ a direct measure of the home share: gross manufacturing production less gross manufacturing production less gross exports, divided by gross manufacturing exports, divided by gross manufacturing production less production less net exports. exports.88 This statistic deserves some consideration on its own. This statistic deserves some consideration on its own.

8 In our counterfactual simulations, we use a different measure, as in Dekle, Eaton, and Kortum (2007).

Putting Ricardo to Work 81

Table 2 reports the home share in 2006 for the 25 countries with data on Table 2 reports the home share in 2006 for the 25 countries with data on gross manufacturing production. The mean value of the home share is just under gross manufacturing production. The mean value of the home share is just under 50 percent. In a world of frictionless trade (all 50 percent. In a world of frictionless trade (all dnini == 1), there is no reason for a 1), there is no reason for a country to spend a larger share of its income on its own goods than any other country to spend a larger share of its income on its own goods than any other country. A country’s home share, in that case, would correspond to its share in country. A country’s home share, in that case, would correspond to its share in world output. As Table 2 makes clear, for each of these countries the home share world output. As Table 2 makes clear, for each of these countries the home share is many times larger than the country’s share in world GDP: three times higher for is many times larger than the country’s share in world GDP: three times higher for the United States, ten times for Germany, 50 times for Denmark, and 100 times for the United States, ten times for Germany, 50 times for Denmark, and 100 times for Greece. Such multiples illustrate the extent to which trade barriers continue to chop Greece. Such multiples illustrate the extent to which trade barriers continue to chop up world markets. Even though countries buy much more of their manufactures up world markets. Even though countries buy much more of their manufactures

Table 2 The Home Share of Spending on Manufactures and Gains from Trade

World GDP share (%) in

2006

Home share of spending Implied gains from trade

Country Level in

2006 (%) Change since 1996 (percentage points)

Level in 2006 (%)

Change since 1996 (percentage points)

Austria 0.66 31.4 –16.2 21.3 8.1 Canada 2.60 49.1 –1.5 12.6 0.6 Czech Republic 0.29 42.6 –14.7 15.3 5.5 Denmark 0.56 25.6 –18.1 25.5 10.7 Estonia 0.03 2.5 –19.6 85.4 56.7 Finland 0.42 58.2 –7.3 9.4 2.1 France 4.60 56.9 –10.3 9.9 3.0 Germany 5.94 53.7 –16.4 10.9 4.8 Greece 0.54 52.7 –11.6 11.3 3.6 Hungary 0.23 26.0 –34.5 25.1 16.4 Iceland 0.03 27.9 –10.0 23.7 6.2 Ireland 0.46 39.6 9.9 16.7 –5.7 Italy 3.80 68.9 –7.1 6.4 1.7 Japan 8.88 84.9 –5.6 2.8 1.1 Korea 1.94 77.2 –0.7 4.4 0.1 Mexico 1.94 58.3 –7.9 9.4 2.3 New Zealand 0.22 53.6 –8.2 11.0 2.6 Norway 0.68 51.9 –2.5 11.6 0.9 Poland 0.69 53.4 –15.8 11.0 4.7 Portugal 0.41 50.8 –10.2 12.0 3.4 Slovenia 0.08 27.2 –15.5 24.3 9.0 Spain 2.51 62.8 –10.2 8.1 2.7 Sweden 0.81 49.2 –10.0 12.5 3.4 Switzerland 0.80 35.3 –20.0 18.9 8.6 United States 27.26 73.5 –8.3 5.3 1.9 All others 33.62

Source: Authors’ calculations from the OECD STAN (STructural ANalysis) Database, the Economist Intelligence Unit, and a model described in the text. Notes: The home share is the share a country spends on domestic manufactures out of total country spending on manufactures. The last two columns calculate the implications of the level of the home share, and its changes over time, for countries’ gains from trade and how those gains have evolved. We look at the gains from trade only in manufactures.

82 Journal of Economic Perspectives

from home than a world of costless trade would predict, in line with theory large from home than a world of costless trade would predict, in line with theory large countries tend to buy much more from themselves than small countries: The overall countries tend to buy much more from themselves than small countries: The overall correlation between home share and share in GDP is close to 0.5 in 2006.correlation between home share and share in GDP is close to 0.5 in 2006.

The third column of Table 2 shows that the home share declined substantially The third column of Table 2 shows that the home share declined substantially between 1996 and 2006, refl ecting globalization of manufactures production over between 1996 and 2006, refl ecting globalization of manufactures production over the period. (Only Ireland bucked this trend.) The last two columns calculate the the period. (Only Ireland bucked this trend.) The last two columns calculate the implications of the level of the home share, and its changes over time, for countries’ implications of the level of the home share, and its changes over time, for countries’ gains from trade and how those gains have evolved. In making these calculations, gains from trade and how those gains have evolved. In making these calculations, our fi rst two embellishments to the model require two modifi cations. Since we our fi rst two embellishments to the model require two modifi cations. Since we look at the gains from trade only in manufactures, the fact that manufactures are look at the gains from trade only in manufactures, the fact that manufactures are only 20 percent of fi nal spending limits the benefi t. But since manufactures are a only 20 percent of fi nal spending limits the benefi t. But since manufactures are a major input into the production of manufactures, there are large indirect benefi ts major input into the production of manufactures, there are large indirect benefi ts of trade in lowering input costs. Putting the two together, the elasticity that trans-of trade in lowering input costs. Putting the two together, the elasticity that trans- lates a smaller home share into larger gains from trade is no longer 1/lates a smaller home share into larger gains from trade is no longer 1/θθ but rather but rather αα/(/(β θβ θ) ) == 1/6 . Thus, we calculate the gains from trade for country 1/6 . Thus, we calculate the gains from trade for country i at date at date t as as

G i t = 100[( π ii t )–1/6 – 1]

where π ii t is country i’s home share at date t.

Clearly, gains from trade are substantial, particularly for small countries: for Clearly, gains from trade are substantial, particularly for small countries: for example over 25 percent of income for Denmark, Estonia, and Hungary. For the example over 25 percent of income for Denmark, Estonia, and Hungary. For the largest countries, Japan and the United States, gains from trade amounted to largest countries, Japan and the United States, gains from trade amounted to 2–3 percent of GDP 20 years ago. But those gains are now over 50 percent higher.2–3 percent of GDP 20 years ago. But those gains are now over 50 percent higher.

Benefi ts of Further Globalization Our measure of the gains from trade compares where we are now with no trade. Our measure of the gains from trade compares where we are now with no trade.

We can also consider the gains that would accrue in the future if globalization, driven We can also consider the gains that would accrue in the future if globalization, driven by lower trade costs, continues. Our counterfactual experiment considers a uniform by lower trade costs, continues. Our counterfactual experiment considers a uniform proportional 25 percent drop in the costs of trade, ( proportional 25 percent drop in the costs of trade, ( ̂̂

d nini == 0.75 for all foreign-country 0.75 for all foreign-country

pairs), a magnitude chosen so that world trade in manufactures approximately pairs), a magnitude chosen so that world trade in manufactures approximately doubles relative to world GDP. As a point of reference, world trade in goods and doubles relative to world GDP. As a point of reference, world trade in goods and services did double relative to world GDP over the past 30 years.services did double relative to world GDP over the past 30 years.

Figure 3 plots the results against each countries’ share of world GDP. The Figure 3 plots the results against each countries’ share of world GDP. The gains, measured by the increase in the real wage, are substantial, with a median gains, measured by the increase in the real wage, are substantial, with a median gain of about 10 percent. The gains are also very heterogeneous, with small coun-gain of about 10 percent. The gains are also very heterogeneous, with small coun- tries typically gaining proportionately much more than large countries. Given their tries typically gaining proportionately much more than large countries. Given their size, isolated countries, such as Iceland, New Zealand, and Greece, gain much size, isolated countries, such as Iceland, New Zealand, and Greece, gain much less than countries proximate to many others, such as Belgium–Luxembourg, the less than countries proximate to many others, such as Belgium–Luxembourg, the Netherlands, and Germany.Netherlands, and Germany.

Benefi ts of Technological Improvements As the basic Ricardian model illustrates, trade provides a conduit through which As the basic Ricardian model illustrates, trade provides a conduit through which

foreign countries benefi t from an improvement in a country’s ability to produce a foreign countries benefi t from an improvement in a country’s ability to produce a good. We can measure the strength of this mechanism by considering the effects good. We can measure the strength of this mechanism by considering the effects

Jonathan Eaton and Samuel Kortum 83

on welfare around the world from a shift in the distribution of technologies in a on welfare around the world from a shift in the distribution of technologies in a particular country particular country i (as refl ected in the parameter (as refl ected in the parameter Aii ). Our particular experiment ). Our particular experiment makes the United States 10 percent more productive, so that makes the United States 10 percent more productive, so that ̂̂ A US == 1.1. 1.1.

The world economy responds in two important ways: First, the U.S. wage rises The world economy responds in two important ways: First, the U.S. wage rises by about 30 percent relative to other countries’ wages. Second, the U.S. real wage by about 30 percent relative to other countries’ wages. Second, the U.S. real wage (in terms of goods and services) rises by about 6 percent, while real wages in other (in terms of goods and services) rises by about 6 percent, while real wages in other countries increase by only a small amount, if at all.countries increase by only a small amount, if at all.

The effects of geography are apparent as the greatest foreign benefi ciaries are The effects of geography are apparent as the greatest foreign benefi ciaries are Canada and Mexico, which experience a real wage gain one-tenth that in the United Canada and Mexico, which experience a real wage gain one-tenth that in the United States. A few countries, if they are initially running a trade surplus in manufactures, States. A few countries, if they are initially running a trade surplus in manufactures, experience a small real wage decline. (If we fi rst eliminate all trade imbalances and experience a small real wage decline. (If we fi rst eliminate all trade imbalances and then increase U.S. technology, all foreign countries experience a real wage gain.)then increase U.S. technology, all foreign countries experience a real wage gain.)

Overall, the increase in U.S. technology raises the GDP-weighted real wage Overall, the increase in U.S. technology raises the GDP-weighted real wage around the world by 1.6 percent, with 8 percent of this gain experienced outside around the world by 1.6 percent, with 8 percent of this gain experienced outside the United States. Foreign countries gain both due to the lower prices of fi nal goods the United States. Foreign countries gain both due to the lower prices of fi nal goods

Figure 3 Real Wage Response to a Decrease in Trade Barriers

Source: Authors’ calculations using data from the OECD STAN (STructural Analysis) Database and the Economist Intelligence Unit and a model described in the text. Notes: We consider a uniform proportional 25 percent drop in the costs of trade, a magnitude chosen so that world trade in manufactures approximately doubles relative to world GDP. The fi gure plots the counterfactual change in real wage against each countries’ share of world GDP.

Australia

Austria

Belgium-Luxembourg

Canada

China

Czech Republic

Denmark

Estonia

Finland France

Germany

Greece

Hungary

Iceland

Ireland

Italy

Japan

Korea

Mexico

Netherlands

New Zealand Norway

Poland Portugal

Slovak RepublicSlovenia

Spain

Sweden

Switzerland

Turkey

United States

ROW

C ou

n te

rf ac

tu al

c h

an ge

( %

) in

r ea

l w ag

e

25

20

15

10

5

0

.001 .01 .1 .5

Share of world GDP

84 Journal of Economic Perspectives

and of intermediate inputs relative to wages. Performing the same experiment, but and of intermediate inputs relative to wages. Performing the same experiment, but with China in place of the United States, yields similar results. Better technology in with China in place of the United States, yields similar results. Better technology in China raises the world’s average real wage by 0.6 percent, with 10 percent of this China raises the world’s average real wage by 0.6 percent, with 10 percent of this gain experienced outside China. These results refl ect the fact that the improvement gain experienced outside China. These results refl ect the fact that the improvement in technology in China adds to a smaller base, yet China’s greater export orienta-in technology in China adds to a smaller base, yet China’s greater export orienta- tion means the overall benefi ts are spread somewhat more to foreign destinations.tion means the overall benefi ts are spread somewhat more to foreign destinations.99

Consequences of Eliminating Current Account Imbalances Our model, like Dornbusch, Fischer, and Samuelson (1977) with trade costs, Our model, like Dornbusch, Fischer, and Samuelson (1977) with trade costs,

implies that transfers between countries have implications for relative wages. Our implies that transfers between countries have implications for relative wages. Our fi nal counterfactual, following Dekle, Eaton, and Kortum (2007), considers exoge-fi nal counterfactual, following Dekle, Eaton, and Kortum (2007), considers exoge- nous shifts in manufacturing trade defi cits that would simultaneously balance every nous shifts in manufacturing trade defi cits that would simultaneously balance every country’s current account, holding fi xed any defi cits outside of manufacturing. We country’s current account, holding fi xed any defi cits outside of manufacturing. We also hold trade costs and technologies fi xed. Table 3 shows the results. To undo the also hold trade costs and technologies fi xed. Table 3 shows the results. To undo the huge 2009 U.S. defi cit, the wage in most countries rises relative to the U.S. wage huge 2009 U.S. defi cit, the wage in most countries rises relative to the U.S. wage by over 13 percent in China and 14 percent in Germany since the large surpluses by over 13 percent in China and 14 percent in Germany since the large surpluses of these two must decline. The small European defi cit countries of Greece and of these two must decline. The small European defi cit countries of Greece and Portugal are the dramatic exceptions, declining 21 and 12 percent relative to the Portugal are the dramatic exceptions, declining 21 and 12 percent relative to the United States.United States.

Figure 4 shows that initial current account balances (as a share of GDP), Figure 4 shows that initial current account balances (as a share of GDP), determining the required adjustment of trade imbalances, go a long way toward determining the required adjustment of trade imbalances, go a long way toward explaining the direction (positive) and magnitude of wage adjustment. A question explaining the direction (positive) and magnitude of wage adjustment. A question is why Iceland, Portugal, and Greece experience very different wage responses even is why Iceland, Portugal, and Greece experience very different wage responses even though their current account defi cit to GDP ratios were similar in 2009. It turns out though their current account defi cit to GDP ratios were similar in 2009. It turns out that another important factor in explaining the magnitude of the change in wages that another important factor in explaining the magnitude of the change in wages is the initial size of the manufacturing sector in a country’s GDP. This share is lowest is the initial size of the manufacturing sector in a country’s GDP. This share is lowest in Greece, worsening the wage decline necessary to bring about current account in Greece, worsening the wage decline necessary to bring about current account balance via an increase in net exports of manufactures.balance via an increase in net exports of manufactures.

The consequences for the real wage are much more muted than those for the The consequences for the real wage are much more muted than those for the relative wage. Even Greece, the most negatively affected, suffers less than a 4 percent relative wage. Even Greece, the most negatively affected, suffers less than a 4 percent decline. The United States, with its large current account defi cit, would see its real decline. The United States, with its large current account defi cit, would see its real wage decline by only half of 1 percent. The reason is a combination of large home wage decline by only half of 1 percent. The reason is a combination of large home shares in manufacturing spending and small shares of manufactures in overall fi nal shares in manufacturing spending and small shares of manufactures in overall fi nal demand. For goods and services produced at home, prices move in line with wages. demand. For goods and services produced at home, prices move in line with wages. The change in the relative wage acts only through import prices.The change in the relative wage acts only through import prices.

More dramatic are the changes in the share of manufacturing in GDP required More dramatic are the changes in the share of manufacturing in GDP required to rebalance current accounts. This share rises by over 10 percentage points in to rebalance current accounts. This share rises by over 10 percentage points in Iceland and by nearly as much in Greece and Portugal. It falls by over 4 percentage Iceland and by nearly as much in Greece and Portugal. It falls by over 4 percentage

9 Our results on the benefi ts of foreign technology are much smaller than some of the results in Eaton and Kortum (2002). The main reason is in that paper the mobile-labor case held wages fi xed so that foreign countries did not suffer a decline in their terms of trade. Our results here, in that respect, are more in line with the immobile-labor case of Eaton and Kortum (2002). See Fieler (2011) and Hsieh and Ossa (2011) for a related analysis of the benefi ts to foreign countries of China’s technology gains. Hsieh and Ossa’s analysis is retrospective rather than counterfactual.

Putting Ricardo to Work 85

points in the large, surplus countries (China and Germany) and by 5 percentage points in the large, surplus countries (China and Germany) and by 5 percentage points in the smaller ones (Norway, Sweden, and Switzerland). These extreme points in the smaller ones (Norway, Sweden, and Switzerland). These extreme predictions about the impact on the size of the manufacturing sector follow from predictions about the impact on the size of the manufacturing sector follow from our Ricardian assumption that labor can fl ow seamlessly between manufacturing our Ricardian assumption that labor can fl ow seamlessly between manufacturing

Table 3 Consequences of Eliminating Current Account Imbalances

Data Counterfactuals

GDP (US$

billions)

Current account balance

(% GDP)

Manufactures trade balance

(% GDP)

Change in Change in mfg share

(percentage points)Country

Relative wage (%)

Real wage (%)

Australia 973.7 –5.0 –8.1 –4.6 –1.4 3.5 Austria 382.0 2.4 1.2 11.4 0.3 –1.9 Belgium-Luxembourg 525.2 0.6 7.4 8.3 0.0 –0.5 Canada 1337.6 –3.4 –4.7 –1.0 –0.7 2.6 China 5050.5 4.7 10.6 13.4 0.3 –4.1 Czech Republic 190.2 –3.7 6.4 3.1 –0.9 3.3 Denmark 308.9 3.1 1.3 13.3 0.4 –2.4 Estonia 19.3 4.2 –3.9 17.5 1.5 –2.6 Finland 241.3 2.0 5.6 11.0 0.1 –1.7 France 2632.7 –2.0 –1.2 4.3 –0.4 1.6 Germany 3308.3 5.2 8.6 14.4 0.7 –4.4 Greece 326.4 –11.5 –12.3 –20.7 –3.7 8.7 Hungary 128.8 –0.1 7.7 7.4 –0.3 0.0 Iceland 12.1 –12.2 3.2 –6.1 –2.1 11.4 Ireland 223.8 –3.4 27.9 4.8 –0.2 3.2 Italy 2116.7 –2.5 2.9 4.1 –0.4 2.1 Japan 5031.6 2.4 3.4 12.7 0.2 –2.0 Korea 834.1 3.5 16.1 11.3 0.2 –3.3 Mexico 879.2 –1.2 –2.9 2.7 –0.4 0.9 Netherlands 796.2 4.4 7.5 13.6 0.7 –3.7 New Zealand 116.2 –3.6 –2.2 1.1 –0.6 2.9 Norway 370.7 11.6 –6.0 41.9 3.9 –4.8 Poland 430.5 –4.4 0.1 1.7 –1.0 3.8 Portugal 234.9 –11.4 –7.6 –11.9 –2.6 9.7 Slovak Republic 87.8 –3.7 6.5 3.3 –0.9 3.3 Slovenia 49.2 –1.7 –1.4 5.0 –0.5 1.4 Spain 1468.4 –5.6 –2.4 –2.0 –1.0 4.7 Sweden 403.5 6.7 4.8 18.6 1.0 –5.2 Switzerland 492.3 7.5 4.6 18.9 1.3 –5.7 Turkey 613.8 –2.7 –2.7 2.9 –0.6 2.2 United States 13939.0 –3.2 –2.6 0.0 –0.5 2.6 ROW 13961.0 0.9 –5.4 9.4 0.2 –0.6

Source: Authors’ calculations from the OECD STAN (STructural ANalysis) Database, the Economist Intelligence Unit, and a model described in the text. Notes: We consider the effects of exogenous shifts in manufacturing trade defi cits that would simultaneously balance every country’s current account, holding fi xed any defi cits outside of manufacturing. Data are for 2009. “Relative wage” is the wage relative to the United States. “ROW” is “rest of world.”

86 Journal of Economic Perspectives

and other activities. In Dekle, Eaton, and Kortum (2008), we introduce rigidities and other activities. In Dekle, Eaton, and Kortum (2008), we introduce rigidities and examine their effect.and examine their effect.

Extending and Improving the Tool

Much recent work has extended this new old Ricardian trade theory in various Much recent work has extended this new old Ricardian trade theory in various ways, sometimes combining elements of it with other theories to address new ques-ways, sometimes combining elements of it with other theories to address new ques- tions. Here we briefl y discuss a few of these contributions.tions. Here we briefl y discuss a few of these contributions.

The fi eld of international trade has traditionally used industry as its unit of The fi eld of international trade has traditionally used industry as its unit of analysis, a natural choice given the heterogeneity of industries and the fact that most analysis, a natural choice given the heterogeneity of industries and the fact that most trade policy is implemented at the industry level. In moving from a small number of trade policy is implemented at the industry level. In moving from a small number of goods, with labor requirements specifi ed in a table, to a continuum of goods, with goods, with labor requirements specifi ed in a table, to a continuum of goods, with labor requirements only described probabilistically, we lose track of this industry labor requirements only described probabilistically, we lose track of this industry dimension. A number of papers have brought industries back into the analysis, dimension. A number of papers have brought industries back into the analysis,

Figure 4 Wage Response to Eliminating Current Account Imbalances

Source: Authors’ calculations using data from the OECD STAN (STructural Analysis) Database and the Economist Intelligence Unit and a model described in the text. Notes: We consider the effects of exogenous shifts in manufacturing trade defi cits that would simultaneously balance every country’s current account, holding fi xed any defi cits outside of manufacturing, as in Table 3. The fi gure plots the counterfactual change in wage relative to the United States against the initial current account balance as a share of GDP. “ROW” is “rest of world.”

Australia

Austria Belgium-Luxembourg

Canada

China

Czech Republic

Denmark

Estonia

Finland

France

Germany

Greece

Hungary

Iceland

IrelandItaly

Japan Korea

Mexico

Netherlands

New Zealand

Norway

Poland

Portugal

Slovak Republic Slovenia

Spain

SwedenSwitzerland

Turkey United States

ROW

C ou

n te

rf ac

tu al

c h

an ge

( %

) in

w ag

e (r

ea lt

iv e

to U

.S . w

ag e)

40

20

0

–20

–40

–15 –10 –5 0 5 10 15

Current account (as % of GDP)

Jonathan Eaton and Samuel Kortum 87

including Chor (2010) and Shikher (2011). The idea is that each industry including Chor (2010) and Shikher (2011). The idea is that each industry k consists consists of a continuum of differentiated goods and each country of a continuum of differentiated goods and each country i has an absolute advantage has an absolute advantage parameter parameter Aikik in each industry. Costinot, Donaldson, and Komunjer (forthcoming) in each industry. Costinot, Donaldson, and Komunjer (forthcoming) use this approach to revisit the connection between trade and industry-level produc-use this approach to revisit the connection between trade and industry-level produc- tivity implied by Ricardian theory, avoiding ambiguities that plagued the early tivity implied by Ricardian theory, avoiding ambiguities that plagued the early analysis of MacDougall (1951, 1952). Incorporating input-output linkages between analysis of MacDougall (1951, 1952). Incorporating input-output linkages between industries, Caliendo and Parro (2010) use the model to explore the welfare gains industries, Caliendo and Parro (2010) use the model to explore the welfare gains from tariff reductions under the North American Free Trade Agreement (NAFTA).from tariff reductions under the North American Free Trade Agreement (NAFTA).

While the basic Ricardian trade model treats labor as the only primary factor, While the basic Ricardian trade model treats labor as the only primary factor, many applications require incorporating other factors of production. In his monu-many applications require incorporating other factors of production. In his monu- mental study measuring the gains from rail transport in nineteenth-century India, mental study measuring the gains from rail transport in nineteenth-century India, Donaldson (2010) applies this Ricardian model, replacing labor with land as the Donaldson (2010) applies this Ricardian model, replacing labor with land as the primary factor, with land rents appearing in place of wages. Incorporating several primary factor, with land rents appearing in place of wages. Incorporating several factors, and multiple industries, leads to a hybrid Ricardian–Heckscher-Ohlin model, factors, and multiple industries, leads to a hybrid Ricardian–Heckscher-Ohlin model, as in Shikher (2011), used by Parro (2012) to account for the rise of the skill premium as in Shikher (2011), used by Parro (2012) to account for the rise of the skill premium in developing and developed countries. Burstein and Vogel (2010) interweave these in developing and developed countries. Burstein and Vogel (2010) interweave these two theories at a deeper level, introducing a correlation between labor requirements two theories at a deeper level, introducing a correlation between labor requirements and skill intensity at the level of the individual goods on the continuum.and skill intensity at the level of the individual goods on the continuum.

Our applications above were limited to trade in manufactures among OECD Our applications above were limited to trade in manufactures among OECD countries. Extending the analysis more broadly, the theory has to confront the countries. Extending the analysis more broadly, the theory has to confront the fact that low-income countries trade less than high-income ones, even taking into fact that low-income countries trade less than high-income ones, even taking into account their economic size and location. Waugh (2010) proposes a model in which account their economic size and location. Waugh (2010) proposes a model in which barriers to exporting are the culprit, consistent with evidence on prices. Fieler (2011) barriers to exporting are the culprit, consistent with evidence on prices. Fieler (2011) pursues another explanation, introducing different classes of goods with different pursues another explanation, introducing different classes of goods with different income elasticities of demand and with different degrees of technological hetero-income elasticities of demand and with different degrees of technological hetero- geneity (in the notation in the model we have presented here, different geneity (in the notation in the model we have presented here, different θθ’s). She ’s). She fi nds that poor countries have a comparative advantage in goods that are both more fi nds that poor countries have a comparative advantage in goods that are both more income inelastic and more technologically homogeneous (that is, with a higher income inelastic and more technologically homogeneous (that is, with a higher θθ). ). Tombe (2011) fi nds that barriers to food trade are higher than for manufactures, Tombe (2011) fi nds that barriers to food trade are higher than for manufactures, particularly in poor countries. He also departs from the standard Ricardian tradition particularly in poor countries. He also departs from the standard Ricardian tradition by introducing barriers to domestic labor mobility between rural areas (where food by introducing barriers to domestic labor mobility between rural areas (where food is produced) and cities (which produce manufactures and services).is produced) and cities (which produce manufactures and services).

In keeping with Ricardo’s original analysis, the models discussed so far mostly In keeping with Ricardo’s original analysis, the models discussed so far mostly assume perfect competition. Breaking with that tradition, in Bernard, Eaton, Jensen, assume perfect competition. Breaking with that tradition, in Bernard, Eaton, Jensen, and Kortum (2003), we incorporate Bertrand competition, allowing the theory to and Kortum (2003), we incorporate Bertrand competition, allowing the theory to make contact with data on individual producers. This extension also opens up the make contact with data on individual producers. This extension also opens up the possibility of addressing pricing puzzles in international economics, as explored in possibility of addressing pricing puzzles in international economics, as explored in Atkeson and Burstein (2008). While the basic model with Bertrand competition Atkeson and Burstein (2008). While the basic model with Bertrand competition yields a distribution of price markups that is invariant to trade, de Blas and Russ yields a distribution of price markups that is invariant to trade, de Blas and Russ (2010) develop a variant of the model that breaks that result. Holmes, Hsu, and Lee (2010) develop a variant of the model that breaks that result. Holmes, Hsu, and Lee (2012) investigate a related model that yields new results on the gains from trade.(2012) investigate a related model that yields new results on the gains from trade.

Having introduced imperfect competition, in Eaton and Kortum (2001) we show Having introduced imperfect competition, in Eaton and Kortum (2001) we show that innovation and growth fi t seamlessly into the theory. Incorporating technology that innovation and growth fi t seamlessly into the theory. Incorporating technology diffusion and multinational production has turned out to be more challenging. The diffusion and multinational production has turned out to be more challenging. The

88 Journal of Economic Perspectives

problem is that the theory can easily deliver myriad treads and risers again when groups problem is that the theory can easily deliver myriad treads and risers again when groups of countries have access to the same technologies for producing some goods. Recent of countries have access to the same technologies for producing some goods. Recent work by Ramondo and Rodríguez-Clare (2009) has begun to map a way through these work by Ramondo and Rodríguez-Clare (2009) has begun to map a way through these diffi culties. Another promising approach, representing a greater departure from the diffi culties. Another promising approach, representing a greater departure from the basic theory, is pursued by Alvarez, Buera, and Lucas (2011).basic theory, is pursued by Alvarez, Buera, and Lucas (2011).

In short, the framework we present in this paper is tractable, versatile, and In short, the framework we present in this paper is tractable, versatile, and amenable to empirical analysis. It is keeping Ricardo busy.amenable to empirical analysis. It is keeping Ricardo busy.

■ We would like to thank Daisuke Fuji, Brodie Olsen, and Sebastian Sotelo for excellent research assistance.

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90 Journal of Economic Perspectives

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  • Putting Ricardo to Work
    • Revisiting Ricardo’s Example
    • Ricardian Trade Theory: From Textbook Example to Practical Tool
      • More Goods
      • More Goods than You Can Count
      • More Countries
      • The Challenge: Many Goods with Many Countries
      • A Solution: Distributions of Worker Requirements
    • Applying the Tool
      • Gains from Trade
      • Benefits of Further Globalization
      • Benefits of Technological Improvements
      • Consequences of Eliminating Current Account Imbalances
    • Extending and Improving the Tool

<< /ASCII85EncodePages false /AllowTransparency false /AutoPositionEPSFiles true /AutoRotatePages /All /Binding /Left /CalGrayProfile (Gray Gamma 2.2) /CalRGBProfile (sRGB IEC61966-2.1) /CalCMYKProfile (U.S. Web Coated \050SWOP\051 v2) /sRGBProfile (sRGB IEC61966-2.1) /CannotEmbedFontPolicy /Warning /CompatibilityLevel 1.4 /CompressObjects /Tags /CompressPages true /ConvertImagesToIndexed true /PassThroughJPEGImages false /CreateJobTicket false /DefaultRenderingIntent /Default /DetectBlends true /DetectCurves 0.1000 /ColorConversionStrategy /UseDeviceIndependentColor /DoThumbnails false /EmbedAllFonts true /EmbedOpenType false /ParseICCProfilesInComments true /EmbedJobOptions true /DSCReportingLevel 0 /EmitDSCWarnings false /EndPage -1 /ImageMemory 1048576 /LockDistillerParams false /MaxSubsetPct 100 /Optimize true /OPM 1 /ParseDSCComments true /ParseDSCCommentsForDocInfo false /PreserveCopyPage true /PreserveDICMYKValues true /PreserveEPSInfo false /PreserveFlatness false /PreserveHalftoneInfo false /PreserveOPIComments false /PreserveOverprintSettings true /StartPage 1 /SubsetFonts true /TransferFunctionInfo /Apply /UCRandBGInfo /Remove /UsePrologue false /ColorSettingsFile () /AlwaysEmbed [ true ] /NeverEmbed [ true ] /AntiAliasColorImages false /CropColorImages false /ColorImageMinResolution 100 /ColorImageMinResolutionPolicy /OK /DownsampleColorImages true /ColorImageDownsampleType /Bicubic /ColorImageResolution 72 /ColorImageDepth -1 /ColorImageMinDownsampleDepth 1 /ColorImageDownsampleThreshold 1.50000 /EncodeColorImages true /ColorImageFilter /DCTEncode /AutoFilterColorImages true /ColorImageAutoFilterStrategy /JPEG /ColorACSImageDict << /QFactor 0.40 /HSamples [1 1 1 1] /VSamples [1 1 1 1] >> /ColorImageDict << /QFactor 1.30 /HSamples [2 1 1 2] /VSamples [2 1 1 2] >> /JPEG2000ColorACSImageDict << /TileWidth 256 /TileHeight 256 /Quality 10 >> /JPEG2000ColorImageDict << /TileWidth 256 /TileHeight 256 /Quality 10 >> /AntiAliasGrayImages false /CropGrayImages false /GrayImageMinResolution 150 /GrayImageMinResolutionPolicy /OK /DownsampleGrayImages true /GrayImageDownsampleType /Bicubic /GrayImageResolution 72 /GrayImageDepth -1 /GrayImageMinDownsampleDepth 2 /GrayImageDownsampleThreshold 1.50000 /EncodeGrayImages true /GrayImageFilter /DCTEncode /AutoFilterGrayImages true /GrayImageAutoFilterStrategy /JPEG /GrayACSImageDict << /QFactor 0.40 /HSamples [1 1 1 1] /VSamples [1 1 1 1] >> /GrayImageDict << /QFactor 1.30 /HSamples [2 1 1 2] /VSamples [2 1 1 2] >> /JPEG2000GrayACSImageDict << /TileWidth 256 /TileHeight 256 /Quality 10 >> /JPEG2000GrayImageDict << /TileWidth 256 /TileHeight 256 /Quality 10 >> /AntiAliasMonoImages false /CropMonoImages false /MonoImageMinResolution 300 /MonoImageMinResolutionPolicy /OK /DownsampleMonoImages true /MonoImageDownsampleType /Bicubic /MonoImageResolution 72 /MonoImageDepth -1 /MonoImageDownsampleThreshold 1.50000 /EncodeMonoImages true /MonoImageFilter /CCITTFaxEncode /MonoImageDict << /K -1 >> /AllowPSXObjects true /CheckCompliance [ /None ] /PDFX1aCheck false /PDFX3Check false /PDFXCompliantPDFOnly false /PDFXNoTrimBoxError true /PDFXTrimBoxToMediaBoxOffset [ 0.00000 0.00000 0.00000 0.00000 ] /PDFXSetBleedBoxToMediaBox true /PDFXBleedBoxToTrimBoxOffset [ 0.00000 0.00000 0.00000 0.00000 ] /PDFXOutputIntentProfile () /PDFXOutputConditionIdentifier () /PDFXOutputCondition () /PDFXRegistryName () /PDFXTrapped /False /CreateJDFFile false /Description << /ENU ([Based on ‘[Smallest File Size]’] Use these settings to create Adobe PDF documents best suited for on-screen display, e-mail, and the Internet. Created PDF documents can be opened with Acrobat and Adobe Reader 5.0 and later.) >> /Namespace [ (Adobe) (Common) (1.0) ] /OtherNamespaces [ << /AsReaderSpreads false /CropImagesToFrames true /ErrorControl /WarnAndContinue /FlattenerIgnoreSpreadOverrides false /IncludeGuidesGrids false /IncludeNonPrinting false /IncludeSlug false /Namespace [ (Adobe) (InDesign) (4.0) ] /OmitPlacedBitmaps false /OmitPlacedEPS false /OmitPlacedPDF false /SimulateOverprint /Legacy >> << /AddBleedMarks false /AddColorBars false /AddCropMarks false /AddPageInfo false /AddRegMarks false /BleedOffset [ 0 0 0 0 ] /ConvertColors /NoConversion /DestinationProfileName (sRGB IEC61966-2.1) /DestinationProfileSelector /UseName /Downsample16BitImages true /FlattenerPreset << /PresetSelector /MediumResolution >> /FormElements false /GenerateStructure false /IncludeBookmarks false /IncludeHyperlinks false /IncludeInteractive false /IncludeLayers false /IncludeProfiles true /MarksOffset 6 /MarksWeight 0.250000 /MultimediaHandling /UseObjectSettings /Namespace [ (Adobe) (CreativeSuite) (2.0) ] /PDFXOutputIntentProfileSelector /NA /PageMarksFile /RomanDefault /PreserveEditing false /UntaggedCMYKHandling /UseDocumentProfile /UntaggedRGBHandling /UseDocumentProfile /UseDocumentBleed false >> << /AllowImageBreaks true /AllowTableBreaks true /ExpandPage false /HonorBaseURL true /HonorRolloverEffect false /IgnoreHTMLPageBreaks false /IncludeHeaderFooter false /MarginOffset [ 0 0 0 0 ] /MetadataAuthor () /MetadataKeywords () /MetadataSubject () /MetadataTitle () /MetricPageSize [ 0 0 ] /MetricUnit /inch /MobileCompatible 0 /Namespace [ (Adobe) (GoLive) (8.0) ] /OpenZoomToHTMLFontSize false /PageOrientation /Portrait /RemoveBackground false /ShrinkContent true /TreatColorsAs /MainMonitorColors /UseEmbeddedProfiles false /UseHTMLTitleAsMetadata true >> ] >> setdistillerparams << /HWResolution [600 600] /PageSize [612.000 792.000] >> setpagedevice