A model that permits intertemporal trade between two countries

1. Consider a model that permits intertemporal trade between two countries. Each country can produce two tradable goods (C and W) and a non-tradable capital good (K) in each period. Each production activity uses L and K; the amount of K in each period is determined by its production in previous periods. In this model, is it possible for one country to have a comparative advantage in the production of both of the traded goods, C and W, in a given period? How does your answer differ from the potential trade pattern based upon comparative advantage in the case of the one- period, two-factor, two-output, Heckscher-Ohlin model? Carefully explain. 2. "When German unity arrived last October, it created visions of an economic colossus, with the nation's export-oriented industry dominating Europe from the Atlantic to the Urals. Six months later, Germany recorded its first monthly trade deficit in nearly a decade. German officials called Monday's release of figures showing a trade deficit of $790 million in April the beginning of a trend that will see Germany importing far more goods than it exports. Otmar Issing, chief economist and board member of the Bundesbank, Gennany's powerful central bank, said today that the April trade deficit was a ‘highly welcome course of events' and would contribute to price stability at home and help spur growth." [New York Times, June 12, 1991, p. C] (a) According to this article, unification has turned Germany fi'om a capital exporter to a capital importer. Carefully explain why the emergence of a trade deficit implies Germany is importing capital. In particular, why doesn‘t a trade deficit (or net import of goods) imply a net export of capital? Explain how real capital can be indirectly transferred between countries when there is only trade in final consumption commodities. (b) Under what initial conditions would such a transfer of capital between countries occur? How does your answer depend upon whether there is secure private ownership of the returns from real capital? Carefiilly explain. 3. Consider a two-country trading-partner relationship (e.g., the US. and Japan in the immediate post-World War period) in which one country (the U.S.) is capital rich and the other (Japan) is capital poor. Suppose both countries can produce capital (K) and a homogeneous consummion good (C) in each of two periods, and that both goods are produced from capital and labor. The capital produced in a given period is assumed to be available for employment in production activities in the period after it is produced. Assume further that capital cannot be transported internationally and thus, cannot be directly exported while units of C can be traded internationally. (3) Suppose that the relatively capital-abundant country (the US.) is the low marginal-cost producer of current consumption goods (Co), while the capital-poor country (Japan) is the relative low marginal-cost producer of capital (K 1). Prior to trade, which country would have a higher real interest rate? Assuming the two countries can engage in mutually beneficial intertemporal trade, what is implied about the current-period balance of trade accounts for the US. and Japan? Carefiilly demonstrate and explain. (b) Carefiilly explain how capital can be indirectly transferred from one country to the other without the actual physical movement of capital. (c) What will happen to the real factor payments to labor and capital over time in Japan? Carefully explain.