Free Trade and Income Redistribution in a Three Factor Model of the U. S. Economy

Abstract

The move toward free trade promises to alter the distribution of income in the U.S. Labor groups generally do not favor the move toward free trade, which can be characterized by the continuing decline in the price of manufactured goods relative to business services. The present study predicts that unskilled labor in the U.S. will lose under a program of free trade, using a general equilibrium model of production. Factor shares, industry shares, and estimates of substitution for skilled labor, unskilled labor, and capital are used to examine comparative statics. The interplay of factor intensity and factor substitution in the three factor production structure has proven a considerable analytical challenge. Building on the textbook production model with two factors, the third productive factor allows technical complementarity and creates a more complex pattern of factor intensity. Both factor intensity and factor substitution affect the qualitative nature of the comparative statics. Little is known about the model's quantitative properties. A 3 x 3 model with outputs of the three major sectors (agriculture, manufacturing, services) is specified, and a 3 x 2 model without agriculture is also examined. Factor substitution is estimated with production function across states. Skilled labor separated by various Census categories cannot be aggregated with unskilled labor in any sector, and constant returns to scale cannot be rejected as a null hypothesis. Additionally, the three inputs (capital, labor, skilled labor) are all technical substitutes. Comparative static results follow a pattern suggested by factor intensity. Changing prices of goods generally have elastic effects on factor prices. Stolper-Samuelson results, in other words, have a quantitative weight. Price changes due to a program of free trade will significantly affect income distribution. Similarly, Rybczynski type results are quantitatively significant in that factor endowment changes have elastic effects on outputs. The implication is that output patterns will differ significantly across freely trading partners. Elasticities of factor prices with respect to endowment changes, on the other hand, are very inelastic. This inelasticity suggests that there would only be small long run effects of international migration, capital flows, or endowment differences on the international pattern of factor income. This inelasticity is called near factor price equalization (NFPE). Under NFPE, freely trading countries will experience a vector of factor prices nearly equal to each other. NFPE suggests that the qualitative effects of changing or different factor endowments