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Does Foreign Productivity Growth Erode Our Competitive Position?
Does Foreign Productivity Growth Erode Our Competitive Position?
1990
US has absolute advantage (higher productivity) in both goods Competitive pricing: Price = [Wage rate] / [Output per worker] Both goods cost $1 in world markets There is no international trade
September 3, 2004 -- 6
1998
Taiwan Output per Price worker 1.1 1.2 Won 0.9 Won 0.8 Won 1
10-20% productivity growth in Taiwan, but not in US At e = 1: U.S. is not competitive in either market Excess demand for Won $ depreciates What is the new exchange rate? Dollar depreciates until U.S. becomes competitive in good A pA $1 = e p* A = 1.1$ / Won Won 0.9
Key point: Countries are automatically competitive, if exchange rates are flexible.
September 3, 2004 -- 7
Pattern of Trade
At the new exchange rate, the dollar price of good B is: e p* B = 1.1 0.8 0.9 U.S. cannot compete in good B Pattern of trade: Taiwan produces all B and exports some to US Taiwan may also produce some A US produces only A and exports some to Taiwan Key insight from trade theory: The pattern of trade depends on comparative advantage, not on absolute advantage. The U.S. has a comparative advantage in A, because its productivity advantage for A is greater than that for B:
U .S . productivity in good A Foreign productivity in good A > U .S . productivity in good B Foreign productivity in good B
Here:
September 3, 2004 -- 8
September 3, 2004 -- 9
10
$0.90 $0.90
The trade pattern and real wages are the same as under flexible exchange rates.
Key insight: Flexible wages ensure that a country remains competitive, even if the exchange rate is fixed
September 3, 2004 -- 10
11
September 3, 2004 -- 11
12
September 3, 2004 -- 12