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Factor Prices and Welfare Under Integrated Capital Markets

  • Carol L. Osler

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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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
Date of revision:
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
Note: ITI IFM
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  1. Torsten Persson, 1983. "Deficits and Intergenerational Welfare in Open Economies," NBER Working Papers 1083, National Bureau of Economic Research, Inc.
  2. Willem H. Buiter, 1979. "Time Preference and International Lending and Borrowing in an Overlapping-Generations Model," NBER Working Papers 0352, National Bureau of Economic Research, Inc.
  3. 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.
  4. Grossman, Gene M., 1984. "The gains from international factor movements," Journal of International Economics, Elsevier, vol. 17(1-2), pages 73-83, August.
  5. 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.
  6. Lars E.O. Svensson, 1982. "Factor Trade and Goods Trade," NBER Working Papers 0999, National Bureau of Economic Research, Inc.
  7. Markusen, James R & Svensson, Lars E O, 1985. "Trade in Goods and Factors with International Differences in Technology," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(1), pages 175-92, February.
  8. Solnik, Bruno H., 1974. "An equilibrium model of the international capital market," Journal of Economic Theory, Elsevier, vol. 8(4), pages 500-524, August.
  9. Gene M. Grossman & Assaf Razin, 1983. "International Capital Movements Under Uncertainty," NBER Working Papers 1075, National Bureau of Economic Research, Inc.
  10. Jacob A. Frenkel & Assaf Razin, 1984. "Fiscal Policies, Debt, and International Economic Interdependence," NBER Working Papers 1266, National Bureau of Economic Research, Inc.
  11. 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.
  12. Markusen, James R., 1983. "Factor movements and commodity trade as complements," Journal of International Economics, Elsevier, vol. 14(3-4), pages 341-356, May.
  13. Sandmo, Agnar, 1970. "The Effect of Uncertainty on Saving Decisions," Review of Economic Studies, Wiley Blackwell, vol. 37(3), pages 353-60, July.
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