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Dale R. DeBoer

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Title: Dale R. DeBoer


1
An Introduction to International Economics
  • Chapter 4 The Heckscher-Ohlin and Other Trade
    Theories
  • Dominick Salvatore
  • John Wiley Sons, Inc.

2
Theories of international trade
  • The previous chapter provided a framework within
    which international trade occurs.
  • This chapter extends this analysis in three ways
  • The cause of comparative advantage is considered.
  • The implications for factors returns are
    considered.
  • Models beyond the standard model of international
    trade are considered.

3
Theories of international trade
  • The theories that will be considered are
  • The Heckscher-Ohlin model of trade
  • An economy of scale model of trade
  • A product differentiation model of trade
  • A product cycle model of trade
  • A transportation cost model of trade
  • A environmental standards model of trade

4
The Heckscher-Ohlin theory
  • The Heckscher-Ohlin (H-O) theory is based on two
    subsidiary theorems
  • The H-O theorem
  • A nation will export the commodity whose
    production requires the intensive use of the
    nations relatively abundant (and therefore,
    cheap) factor and import the commodity whose
    production requires the intensive use of the
    nations relatively scarce (and therefore,
    expensive) factor.
  • In other words, relative factor abundance drives
    comparative advantage and the pattern of trade.

5
The Heckscher-Ohlin theory
  • The Heckscher-Ohlin (H-O) theory is based on two
    subsidiary theorems
  • The H-O theorem
  • The factor price equalization theorem
  • International trade will bring about equalization
    in the relative and absolute returns to
    homogenous factors across nations.
  • In other words, wages and other factor returns
    will be the same after specialization and trade
    has occurred.

6
Demonstrating the H-O theorem
  • Suppose there are two countries with identical
    technology and societal preferences.
  • The nations differ in that one is relatively
    labor abundant while the other is relatively
    capital abundant.
  • Factor abundance is determined by the ratio of
    capital (K) to labor (L) available in the
    countries.
  • The country with the greater K/L ratio is defined
    as being capital abundant.

7
Demonstrating the H-O theorem
  • The nations differ in that one is relatively
    labor abundant while the other is relatively
    capital abundant.
  • Further, the commodities produced differ in
    factor intensity.
  • Factor intensity is determined by the ratio of
    capital (K) to labor (L) required for the
    production of the commodity.
  • The commodity requiring the greater K/L ratio per
    unit of production is defined as being capital
    intensive.

8
Demonstrating the H-O theorem
  • Further, the commodities produced differ in
    factor intensity.
  • Under these assumptions, the PPFs indicated on
    the next slide will show the relative productive
    potential of the trading nations if Nation 1 is
    labor abundant and Nation 2 is capital abundant
    while commodity Y is labor intensive while
    commodity X is capital intensive.

9
Demonstrating the H-O theorem
Nation 2
Nation 1
Y
Y
X
X
10
Demonstrating the H-O theorem
  • For ease of presentation, the two PPFs may be
    overlaid in one diagram.
  • Under the assumption of identical societal
    preferences, this yeilds a possible community
    indifference with the indicated shape.

Y
X
11
Demonstrating the H-O theorem
  • This combination of PPFs and community
    indifference curves establishes a higher
    opportunity cost for Nation 1 in the production
    of X.
  • Using the logic of the standard model of trade
    this shows that Nation1 will specialize in the
    production of and export Y.

Y
X
12
Factor price equalization
  • In the H-O model of trade, the pattern of trade
    is driven by relative factor abundance.
  • Labor abundant countries export goods that are
    labor intensive in their production.
  • Capital abundant countries export goods that are
    capital intensive in their production.

13
Factor price equalization
  • In the H-O model of trade, the pattern of trade
    is driven by relative factor abundance.
  • Exported commodities experience an increase in
    their price relative to the autarky situation.

14
Factor price equalization
  • In the H-O model of trade, the pattern of trade
    is driven by relative factor abundance.
  • Exported commodities experience an increase in
    their price relative to the autarky situation.
  • The Stolper-Samuelson theorem demonstrates that
    an increase in the relative price of a commodity
    raises the return of the factor used intensively
    in its production.
  • At the same time, the return of the relative
    scarce factor will fall.

15
Factor price equalization
  • Exported commodities experience an increase in
    their price relative to the autarky situation.
  • The Stolper-Samuelson theorem demonstrates that
    an increase in the relative price of a commodity
    raises the return of the factor used intensively
    in its production.
  • Thus, the labor abundant country will see an
    increase in wages, but a fall in the return to
    capital while the capital abundant country will
    experience the opposite pattern of change.

16
Implications of FPE
  • Developed nations are expected to be capital
    abundant.
  • Therefore, following the opening of trade the
    return to capital in the developed countries is
    expected to increase and wages are expected to
    fall.
  • This pattern of change should worsen inequality
    in the developed countries.

17
Implications of FPE
  • Developed nations are expected to be capital
    abundant.
  • The change in inequality should be the opposite
    for the developing (and labor abundant) countries.

18
Implications of FPE
  • Developed nations are expected to be capital
    abundant.
  • The change in inequality should be the opposite
    for the developing (and labor abundant)
    countries.
  • The conclusion of worsened inequality in the
    developed world holds only if
  • The assumptions of the H-O theory holds.
  • As will be seen, this may not be the case.
  • The Stolper-Samuelson theorem is the only force
    driving changes in inequality.

19
Empirical tests of the H-O theory
  • The Leontief Paradox
  • A 1951 test of the H-O theory
  • Showed that that pattern of trade did not fit the
    conclusions of the H-O theorem.
  • Imports in the U.S. were capital intensive when
    they should have been labor intensive.

20
Empirical tests of the H-O theory
  • The Leontief Paradox
  • Is the paradox real?
  • The test assumed a two factor world which
    required assumptions about what is capital and
    what is labor.
  • The test assumed consistent technology between
    nations.
  • However, technology varies so this assumption may
    have biased the test.

21
Empirical tests of the H-O theory
  • The Leontief Paradox
  • Is the paradox real?
  • The test assumed a two factor world which
    required assumptions about what is capital and
    what is labor.
  • The test assumed consistent technology between
    nations.
  • The test assumes perfect mobility between factors
    of production.
  • In practice, some factors of production are
    specific to sectors of the economy.
  • Sector specific factors alter the predictions of
    the H-O theory and require a different testing
    procedure.

22
Empirical tests of the H-O theory
  • The Leontief Paradox
  • Is the paradox real?
  • More current test of the H-O theory are built on
    multiple factor (including sector specific
    factors) models that extend the basic H-O
    framework. These show good predictive ability.

23
An economy of scale model of trade
  • Some productive relationships are characterized
    by increasing returns to scale.
  • A production situation where output grows
    proportionally more than the increase in inputs
    to the productive process.
  • A doubling of inputs more than doubles outputs.

24
An economy of scale model of trade
  • Some productive relationships are characterized
    by increasing returns to scale.
  • In this situation, production on a larger scale
    lowers per unit costs of production and provides
    a new source of cost advantage on which to base
    exports.

25
Product differentiation based trade
  • Differentiated products
  • Similar products produced by different
    manufacturers in the same industry or general
    trade group.
  • Toyota and Ford automobiles are differentiated
    products

26
Product differentiation based trade
  • Differentiated products
  • Intra-industry trade may arise from product
    differentiation.
  • Intra-industry trade is international trade in
    differentiated products.

27
Product differentiation based trade
  • Differentiated products
  • Intra-industry trade may arise from product
    differentiation.
  • Reasons for intra-industry trade
  • Allows producers to exploit product specific
    economies of scale.
  • Allows consumers to benefit from product variety
    that would not exist without international trade.

28
The product cycle model of trade
  • Advanced industrialized countries develop and
    introduce new products
  • While only one country possess the product, it
    possesses international monopoly power and will
    be the sole exporter of the product.

29
The product cycle model of trade
  • Advanced industrialized countries develop and
    introduce new products
  • As the technology producing the product becomes
    more widespread, production will spread to other
    nations.
  • This moves international trade to a standard
    comparative advantage framework.

30
The product cycle model of trade
  • Advanced industrialized countries develop and
    introduce new products
  • As the technology producing the product becomes
    more widespread, production will spread to other
    nations.
  • As production becomes standardized, the original
    introducer of the product loses its
    technologically based comparative advantage in
    the production of the product and becomes an
    importer of the product.

31
Examples of product cycles
  • Television
  • The Television History WWW site provides a nice
    discussion of the history of television. A look
    at the manufacturers of televisions provides a
    good example of the product cycle model.
  • WWW link to the Television History Site
  • WWW link to the list of television manufacturers

32
Transportation cost models of trade
  • Transportation costs
  • Transportation costs are the freight charges,
    warehousing costs, costs of loading and
    unloading, insurance premiums, and interest
    charges incurred while goods are in transit
    between nations.

33
Transportation cost models of trade
  • Transportation costs
  • The introduction of transportation costs into the
    standard model of trade may eliminate a countrys
    comparative advantage in the production of an
    item.
  • High enough costs may result in an item not being
    able to be traded.
  • Highly perishable food products may suffer this
    fate.

34
Transportation cost models of trade
  • Transportation costs may provide an advantage for
    trade between geographically close countries.
  • This serves as partial explanation for why Canada
    and Mexico are the two largest trading partners
    of the US.
  • WWW link to International Trade Administration
    data on major US trading partners

35
Environmental standards and trade
  • A nations environmental standards determine the
    level of acceptable pollution that may be
    generated from production.

36
Environmental standards and trade
  • A nations environmental standards determine the
    level of acceptable pollution that may be
    generated from production.
  • Strict environmental standards are expected to
    raise the costs of production.
  • These increased costs may reduce (or remove) a
    countrys comparative advantage in production and
    alter the pattern of trade.

37
Environmental standards and trade
  • A nations environmental standards determine the
    level of acceptable pollution that may be
    generated from production.
  • Strict environmental standards are expected to
    raise the costs of production.
  • In order to maintain comparative advantage, a
    nation may reduce its environmental protections.
  • This may spur a race to the bottom.

38
Environmental standards and trade
  • In order to maintain comparative advantage, a
    nation may reduce its environmental protections.
  • This concern has spurred calls for inclusion of
    environmental legislation along with agreements
    to lower barriers to trade.
  • For instance, the environmental rider attached to
    the NAFTA.
  • The Foreign Trade Information System has a good
    discussion of this policy by Hufbauer and Oreja.
  • WWW link
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