Trade, Migration and the Price of a Haircut: In the text, we discussed the similarities between outsourcing and immigration — and with it the similarity between trading goods and moving workers. The implicit assumption in our discussion, however, was that it was in fact possible to produce the “goods” anywhere and sell them anywhere else. Dramatic drops in transportation costs have made this assumption reasonable in many—but not all—cases. In this exercise, we consider a case where the assumption does not hold—haircuts.
A. Suppose haircuts are considerably cheaper in Mexico than they are in the U.S.
(a) When barriers to the flow of goods between the U.S. and Mexico are removed (but barriers to migration remain), why might you not expect the price of haircuts in the U.S. to converge to the price of haircuts in Mexico but you might expect the price of apples in Mexico to converge to the price of apples in the U.S.?
(b) Suppose the barriers to migration instead of the barriers to trade had come down. How would your answer to (a) differ?
(c) Now consider this a bit more carefully. Begin by considering two sectors in the Mexican economy: The sector for tradable goods (like apples) and the sector for non-tradable goods (like haircuts). Before any trade or migration between Mexico and the U.S., suppose the labor market in Mexico is in equilibrium—with wages in the two Mexican sectors equal to one another. Illustrate the initial labor market equilibrium in Mexico in two graphs — one with demand and supply in the tradable sector, the other with demand and supply in the non-tradable sector.
(d) Suppose trade in goods opens between the U.S. and Mexico. As a result, some U.S. companies that produce tradable goods relocate to Mexico, hire the lower-wage workers in Mexico and then export the goods to the U.S. (and other countries). What happens to the Mexican wage in the tradable sector?
(e) Suppose workers can move across sectors— i.e. someone who cuts hair for a living can also work in an apple processing plant. If this is the case, what will happen in the Mexican labor market? What will happen to the price of haircuts in Mexico?
(f) True or False: Even when migration of labor across national boundaries is not permitted, we would expect a drop in the barriers to trade in goods to result in wage movements that are similar in tradable and non-tradable sectors of both economies so long as labor is substitutable across sectors within an economy.
(g) Does an analogous process happen between the tradable and non-tradable sector in the U.S.?
Might you expect the price of haircuts to converge across Mexico and the U.S. after all?
B. Consider two sectors in the Mexican and U.S. economies: Tradable goods (like apples) and non tradable goods (like haircuts). Suppose that Mexican labor demand and supply in the tradable sector is characterized by the equations ld (w) = (A−w)/α and ls (w) = (B +w)/β. Suppose the same holds in the non-tradable sector, and suppose that initially there is no trade or migration between Mexico and the U.S., with wages across the two sectors in Mexico equal.
(a) Let A = 100,000, B = −1,000, α = 0.01 and β= 0.001. What is the equilibrium wage in Mexico —and what is the employment level in each sector?
(b) Suppose next that trade in goods opens between the U.S. and Mexico. As a result, demand for labor in the tradable sector increases—with A increasing to 210,000 in the tradable sector. If there is no labor mobility across sectors in Mexico, what wage emerges in the tradable goods sector in Mexico?
(c) Suppose that labor can easily cross sectors within Mexico. What is the equilibrium Mexican wage that emerges?
(d) What is the employment level in each sector in the new equilibrium?