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Factor Prices and Welfare Under Integrated Capital Markets

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  • Carol L. Osler

Abstract

This paper considers the effect on factor prices and welfare of trade between economies whose production is characterized by nation-specific technological uncertainty. The analysis is carried out using a two-country Diamond overlapping-generations model in which technological uncertainty is reflected in factor prices, and "equities" refer to claims on the returns to capital. We find that trade in capital is complementary to trade in commodities, in the sense that adding free trade in capital to the spectrum of permitted economic activities will cause significant changes in wages, output, and capital returns. Furthermore, for countries which are identical, or not very different, factor prices move in parallel when free trade in capital is introduced. Specifically, as we show in the text, capital returns fall, while wages rise, in both countries. These results are based on the portfolio diversification permitted by international capital market integration: the reduction of portfolio risk associated with portfolio diversification induces adjustments in savings behavior which, in turn, change factor prices. In the realm of normative economics we find that, upon the introduction of free trade in capital, the associated changes in portfolio risk and factor returns have welfare effects entirely distinct from those conventionally associated with open markets for goods.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2447.

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Date of creation: Nov 1987
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Publication status: published as "Explaining the Absence of International Factor-Price Convergence" Journal of International Money and Finance, Vol. 10, No. 1, (March 1991).
Handle: RePEc:nbr:nberwo:2447

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  1. Jacob A. Frenkel & Assaf Razin, 1984. "Fiscal Policies, Debt, and International Economic Interdependence," NBER Working Papers 1266, National Bureau of Economic Research, Inc.
  2. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467.
  3. Grossman, Gene M., 1984. "The gains from international factor movements," Journal of International Economics, Elsevier, vol. 17(1-2), pages 73-83, August.
  4. Helpman, Elhanan & Razin, Assaf, 1978. "Uncertainty and International Trade in the Presence of Stock Markets," Review of Economic Studies, Wiley Blackwell, vol. 45(2), pages 239-50, June.
  5. Svensson, Lars E.O., 1984. "Factor trade and goods trade," Journal of International Economics, Elsevier, vol. 16(3-4), pages 365-378, May.
  6. James R. Markusen & Lars E.O. Svensson, 1983. "Trade in Goods and Factors with International Differences in Technology," NBER Working Papers 1101, National Bureau of Economic Research, Inc.
  7. Solnik, Bruno H., 1974. "An equilibrium model of the international capital market," Journal of Economic Theory, Elsevier, vol. 8(4), pages 500-524, August.
  8. Persson, Torsten, 1985. "Deficits and intergenerational welfare in open economies," Journal of International Economics, Elsevier, vol. 19(1-2), pages 67-84, August.
  9. Gene M. Grossman & Assaf Razin, 1983. "International Capital Movements Under Uncertainty," NBER Working Papers 1075, National Bureau of Economic Research, Inc.
  10. Sandmo, Agnar, 1970. "The Effect of Uncertainty on Saving Decisions," Review of Economic Studies, Wiley Blackwell, vol. 37(3), pages 353-60, July.
  11. Buiter, Willem H, 1981. "Time Preference and International Lending and Borrowing in an Overlapping-Generations Model," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 769-97, August.
  12. Baron, David P. & Forsythe, Robert., . "Models of the Firm and International Trade Under Uncertainty," Working Papers 183, California Institute of Technology, Division of the Humanities and Social Sciences.
  13. Markusen, James R., 1983. "Factor movements and commodity trade as complements," Journal of International Economics, Elsevier, vol. 14(3-4), pages 341-356, May.
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