Adding Transport Costs and Nontraded Goods

Adding Transport Costs and Nontraded Goods
We now extend our model another step closer to reality by considering the effects of transport
costs. Transportation costs do not change the fundamental principles of comparative advantage
or the gains from trade. Because transport costs pose obstacles to the movement of goods
and services, however, they have important implications for the way a trading world economy
Relative quantity
of labor, L /L*
Relative wage
rate, w/w*
10
8
4
3
2
0.75
Apples
Bananas
Caviar
Dates
Enchiladas
RD
RS
Figure 3-5
Determination of Relative Wages
In a many-good Ricardian model,
relative wages are determined by
the intersection of the derived
relative demand curve for labor,
RD, with the relative supply, RS.
44 PART ONE International Trade Theory
is affected by a variety of factors such as foreign aid, international investment, and balance of
payments problems. While we will not deal with the effects of these factors yet, the multigood
one-factor model is a good place to introduce the effects of transport costs.
First, notice that the world economy described by the model of the last section is marked
by very extreme international specialization. At most there is one good that both countries
produce; all other goods are produced either in Home or in Foreign, but not in both.
There are three main reasons why specialization in the real international economy is
not this extreme:
1. The existence of more than one factor of production reduces the tendency toward specialization
(as we will see in the next two chapters).
2. Countries sometimes protect industries from foreign competition (discussed at length
in Chapters 9 through 12).
3. It is costly to transport goods and services; in some cases the cost of transportation is
enough to lead countries into self-sufficiency in certain sectors.
In the multigood example of the last section, we found that at a relative Home wage
of 3, Home could produce apples, bananas, and caviar more cheaply than Foreign, while
Foreign could produce dates and enchiladas more cheaply than Home. In the absence of
transport costs, then, Home will export the first three goods and import the last two.
Now suppose there is a cost to transport goods, and that this transport cost is a uniform
fraction of production cost, say 100 percent. This transportation cost will discourage trade.
Consider dates, for example. One unit of this good requires 6 hours of Home labor or
12 hours of Foreign labor to produce. At a relative wage of 3, 12 hours of Foreign labor
costs only as much as 4 hours of Home labor; so in the absence of transport costs, Home
imports dates. With a 100 percent transport cost, however, importing dates would cost the
equivalent of 8 hours of Home labor (4 hours of labor plus the equivalent of 4 hours for the
transportation costs), so Home will produce the good for itself instead.
A similar cost comparison shows that Foreign will find it cheaper to produce its own
caviar than to import it. A unit of caviar requires 3 hours of Home labor to produce. Even
at a relative Home wage of 3, which makes this the equivalent of 9 hours of Foreign labor,
this is cheaper than the 12 hours Foreign would need to produce caviar for itself. In the absence
of transport costs, then, Foreign would find it cheaper to import caviar than to make
it domestically. With a 100 percent cost of transportation, however, imported caviar would
cost the equivalent of 18 hours of Foreign labor and would therefore be produced locally
instead.
The result of introducing transport costs in this example, then, is that Home will still
export apples and bananas and import enchiladas, but caviar and dates will become
nontraded goods, which each country will produce for itself.
In this example we have assumed that transport costs are the same fraction of production
cost in all sectors. In practice there is a wide range of transportation costs. In some
cases transportation is virtually impossible: Services such as haircuts and auto repair cannot
be traded internationally (except where there is a metropolitan area that straddles a
border, like Detroit, Michigan–Windsor, Ontario). There is also little international trade in
goods with high weight-to-value ratios, like cement. (It is simply not worth the transport
cost of importing cement, even if it can be produced much more cheaply abroad.) Many
goods end up being nontraded either because of the absence of strong national cost advantages
or because of high transportation costs.
The important point is that nations spend a large share of their income on nontraded
goods. This observation is of surprising importance in our later discussion of international
monetary economics.