Question

As a result of the North American Free Trade Agreement (NAFTA), the United States and Canada shifted toward free trade with Mexico. According to the Stolper–Samuelson theorem, how did this shift affect the real wage of unskilled labor in Mexico? In the United States or Canada? How did it affect the real wage of skilled labor in Mexico? In the United States or Canada?

Please No bad handwriting. I need to understand it. Thanks!

Answer 1

According to the Stolper-Samuelson theorem, when the relative price of a good rises, the factor prices for that factor which is used intensively in the production of that good rises and vice versa. It means that if relative price of labor intensive good rises, the wages of labor will rise.

Now, coming back to the given situation, Mexico largely unskilled workers and thus, a comparative advantage in production of unskilled labour intensive good. Unlike Mexico, US and Canada have skilled labours and thus, they have comparative advantage in skilled goods production.

A. After NAFTA, the Mexico started exporting unskilled labour intensive goods and thus, the demand for those labors rose. This should according to Stolper-Samuelson theorem lead to increase in the wages of unskilled labors in Mexico.

B. The unskilled labors in United States and Canada, now face threat from imported unskilled labour intensive goods from Mexico. Thus, the demand for unskilled labors in Canada and United States would fall. As a result, their wages would fall as well.

C. The skilled labors in Mexico face competition from American and Canadian skill intensive goods. Thus, the demand for skilled labour in Mexico will fall. This would lead to a fall in their wages.

D. The United States and Canada have comparative advantage in the production of skill intensive goods due to abundant skilled labor. Thus, these countries produce more of skill intensive goods after trade agreement.

Producing more of these goods require that more skilled labour be employed and thus, the demand for skilled labour would rise. As a result the real wages of skilled labor in US nad Canada rise.