I've tried to make a powerful case to you in previous sections, that trade benefits every country that engages in it. And therefore, free trade should be encouraged, if what we want to do is raise the benefits to the world, and raise the standard of living to the world, the consumer surplus which is our definition of welfare. However, there is something that cannot be overlooked and this is also important in today's political debate. There are some people within each country that are hurt by trade even though both countries gain. I want to repeat this. There are losers from trade, which is not one country wins one country loses. No. Both countries win, but within each country, there is a group of people who will lose. So, we're going to look at the topic of trade and factor in incomes, to see who these people are that lose from trade. And this will help us to understand why there is sometimes a backlash against free trade, as there is at the present time in many political situations. The names of the economists are associated with this discussion of trade and factor incomes are; Heckscher, Ohlin, Stolper, Samuelson. I'm not going to give you the names of all the theorems, but if you've studied Economics, you may have heard these names. What basically they're arguing, is that, if we have this simple world we've been talking about with two goods, or two kinds of goods, and two countries, as countries engage in trade, certain things will happen. So, let's imagine a world where one country had a lot of capital. Meaning machinery and equipment. A lot of capital relative to the number of workers it has. In other words, it's a rich country, it's invested a lot over time, it has workers, but each worker has a lot of capital to work with. Then there's another country that has actually a lot of workers, maybe unskilled workers relative to capital. This is a poorer country. The investment process has been more recent. So, we look at the capital labor ratios and we find country one, would be a country that is rich in one resource, abundant in one resource. Country two, is abundant in the other resource. In the table I'm giving you, we've got country one abundant in labor, country two abundant in capital and that's based on their capital labor ratios. Now, if I'm abundant in labor, it's likely that I'm going to be more efficient, and more competitive at producing goods that use labor intensively. Goods that use a lot of labor relative to capital. It could be cheaper, won't it? Because I'm paying more wages than return to capital, okay? So, country one, which is abundant in labor, will tend to have an advantage in those goods that use labor intensively. Therefore, that country will tend to export the types of goods that use labor intensively, and it will tend to import the types of goods that do not use labor intensively. Maybe goods that use capital intensively instead, okay? So that's country one. It's got a lot of labor relative to capital. So, its advantage is in labor intensive products. It tends to export those labor intensive products because it has a price advantage there, import capital intensive products. Now, the other country in the world is country two. There are two factors in the world, labor and capital. So country two we've said, is more abundant in capital relative to labor. So country two, will have a price advantage. A competitive advantage in goods that use capital intensively, okay? Now, you can imagine this, maybe a labor intensive good would be a textile, where there's lots of manual work relative to the machine. Maybe a capital intensive good would be an automobile, where there's a lot of machine work, relative to the number of workers you'd use, okay? So, country two, which is abundant in capital, tends to have an advantage in goods that use capital intensively, okay? It will tend to export those goods because it has this price advantage. It will tend to import the goods that use labor intensively because there, it's not competitive. So you can see what the patterns of trade are. Country one will export these labor intensive goods, country two will export the capital intensive goods. As we predicted in the previous sessions, everybody's going to gain, both countries are going to gain. But, within a country there's a dynamic that goes into motion. In here, I want you to have in your mind too and you might even want to draw it. Draw it on a sheet of paper. I want you to have in your mind a supply and demand diagram. Let's go to country one, the country with lots of unskilled workers. You can draw a supply and demand diagram for workers, for unskilled labor. Now, in country one, if we start to specialize in goods that use unskilled labor intensively, and we start to export those goods, we're going to be producing more of them. Therefore, they will be more need for labor. Therefore, the demand for labor will increase. Now, if you do that on your graph you're going to see the result will be the price of labor which is the wage, will also increase. So in country one, the unskilled worker benefits, okay? And we see this in countries like China, India where hundreds of millions of people are coming out of poverty, because the country is specializing in goods that use labor intensively. Country two on the other hand, which is a capital abundant country exporting capital intensive goods, this is probably a rich country, a developed country. Draw your supply and demand diagram for unskilled workers, okay? In country two, the country is going to begin to import goods that use unskilled labor. Therefore, it doesn't need as much unskilled labor at home. Therefore, your demand curve will shift inward to the left, and you find your new equilibrium is a lower wage rate, okay? Now, this is a really important conclusion. What we find is that in country one, which is that labor abundant country because of this natural specialization in trade and goods, the wages of unskilled labor will go up. There will be actually more equality in this country, and a middle class will start to grow. But in country two, which is a rich country, capital abundant, the wages of unskilled labor will tend to fall. Therefore, we're going to find in this country inequality is getting larger. The difference between the rich and the poor is getting greater, and the person that's going to be hurt is the unskilled worker. This is a really important conclusion for you to keep in your minds because part of this is playing out on our national political scenes today.
