The HeckscherOhlin Model: Features, Flaws, and Fixes I: What's the HO Model Like

1
The Heckscher-Ohlin Model Features, Flaws, and
FixesI What's the H-O ModelLike

• Alan V. Deardorff
• University of Michigan

2
Themes of the 3 Lectures

• The HO Model is largely well behaved in 2
  dimensions, even when you include trade costs
• In higher dimensions, it is not so well behaved,
  especially when you include trade costs
• Various modifications and extensions of the HO
  model offer some promise of making it behave
  better

3
Outline of Lecture I

• Overview of the H-O Model
• The 22 Model
• Without trade costs
• With trade costs
• The 222 Model
• Conclusions from the 22(2) Model

4
H-O Overview

• The Heckscher-Ohlin (H-O) Model Assumptions
• Homogeneous goods and factors
• Perfectly competitive market equilibrium
  throughout (goods and factors)
• Production functions
• Constant returns to scale
• Non-joint
• Factors
• Perfectly mobile across industries
• Perfectly immobile across countries
• Countries differ in factor endowments
• Industries differ in factor intensities

5
H-O Overview

• The Heckscher-Ohlin (H-O) Model Implications
• Countries export goods that use intensively their
  abundant factors (H-O Thm)
• Trade draws factor prices closer together across
  countries, becoming equal in certain
  circumstances (FPE Thm)
• Trade changes real factor prices (S-S Thm)
• Benefiting owners of abundant factors
• Hurting owners of scarce factors
• Rybczynski Thm (output effects of factor
  accumulation)

6
The Textbook 22 H-O Model

• Goods X, Y
• Factors K, L
• X is K-intensive
• Goods are final goods
• Trade is
• Free and frictionless, or
• Subject to simple, constant trade costs per unit
  (perhaps iceberg)

7
The Textbook 22 H-O Model

• Analysis Expanded Lerner Diagram shows
• Production
• Factor allocations
• Factor Prices
• Trade
• for given
• Goods prices
• Factor endowments

• Thus
• Full solution for small open economy
• Dependence on prices for large economy

8
Lerner Diagram
K
X1/PX0
1/wK0
Y1/PY0
1/wL0
L
9
Lerner Diagram
K
E0
X0
X1/PX0
1/wK0
Y1/PY0
Y0
1/wL0
L
10
Lerner Diagram
Export
K
E0
X0
EC
EW
X1/PX0
XC
1/wK0
YC
Y1/PY0
Y0
Import
1/wL0
L
11
The Textbook 22 H-O Model

• Behavior
• If Endowments inside Diversification Cone
• Both goods produced
• Factor prices independent of endowments
• If Endowments outside Diversification Cone
• One good produced
• Factor prices depend on endowments

12
The Textbook 22 H-O Model

• Sensitivity
• All variables (outputs, trade, factor prices) are
  uniquely determined and depend smoothly on
• Endowments
• Prices
• Adding trade costs vis a vis a single other
  country
• Creates range of world prices for which country
  does not trade
• Outside that range, all variables depend smoothly
  on trade costs

13
The Textbook 22 H-O Model

• Summary
• With free and frictionless trade

14
The Textbook 22 H-O Model

• Summary
• With iceberg trade costs, t

15
Effects of Increasing Capital Endowment, EK
K
EK
X1/PX0
1/wK0
cone
Y1/PY0
1/wL0
L
16
Effects of Increasing EK
SX
SX
Rybczynski Thm SX/EK, rises with EK
EK
cone
17
Effects of Increasing EK
SY
Rybczynski Thm SY Falls with EK
SY
EK
cone
18
Effects of Increasing EK
DX, DY
DX
DY
EK
cone
19
Effects of Increasing EK
TX, TY
TX
EK
TY
cone
20
Effects of Increasing EK
wK
wK0
wK
EK
wL
wL
wL0
EK
cone
21
Effects of Increasing Labor Endowment, EL
K
X1/PX0
1/wK0
Effects are mirror image of increasing EK
EL
Y1/PY0
1/wL0
L
22
Effects of Increasing Price of X, PX
K
X1/PX0
1/wK0
Y1/PY0
1/wL0
L
23
Effects of Increasing Price of X, PX
K
X1/PX0
1/wK0
Y1/PY0
1/wL0
L
24
Effects of Increasing Price of X, PX
K
X1/PX0
1/wK0
Y1/PY0
1/wL0
L
25
Effects of Increasing Price of X, PX
SX
SX
PX
(cone)
26
Effects of Increasing Price of X, PX
SY
SY
PX
(cone)
27
Effects of Increasing Price of X, PX
DX, DY
DY
DX
PX
(cone)
28
Effects of Increasing Price of X, PX
TX, TY
TX
PX
TY
(cone)
29
Effects of Increasing Price of X, PX
wK
wK
Stolper-Samuelson Thm wK/PX, wK/PY rise with PX
PX
(cone)
30
Effects of Increasing Price of X, PX
Stolper-Samuelson Thm wL/PX, wL/PY fall with PX
wL
wL
PX
(cone)
31
Effects of Increasing Price of Y, PY

• Effects are mirror image of increasing PX

32
Effects of Presence of Trade Costs

• Assume iceberg trade cost t-1gt0, equals fraction
  of each good that disappears in transit to world
  market (must ship t for 1 to arrive)
• Implication for domestic prices if world prices
  are PXw, PYw
• If country exports X PXPXw/t PYtPYw
• If country exports Y PYPYw/t PXtPXw
• If country does not trade
• (PXw/PYw)/t2 PX/PY t2(PXw/PYw)

33
Presence of Trade Costs
K
EC
X1/PXw
1/wKw
Y1/PYw
1/wLw
L
34
Presence of Trade Costs
If country exports X
K
which it will if endowment is above this line
ECX
EC
X1/PXw
1/wKw
Y1/PYw
1/wLw
L
35
Presence of Trade Costs
K
EC
X1/PXw
ECY
1/wKw
If country exports Y
which it will if endowment is
below this line
Y1/PYw
1/wLw
L
36
Presence of Trade Costs
If country exports X
K
autarky
ECX
EC
X1/PXw
ECY
1/wKw
If country exports Y
Y1/PYw
1/wLw
L
37
Effects of Increasing EK in Presence of Trade
Costs
If country exports X
K
autarky
ECX
EC
X1/PXw
ECY
1/wKw
If country exports Y
Y1/PYw
1/wLw
L
38
Effects of Increasing EK in Presence of Trade
Costs
PX/PY
autarky
t2PXw/PYw
PXw/PYwt2
EK
X-export cone
Y-export cone
39
Effects of Increasing EK in Presence of Trade
Costs
SX
autarky
EK
X-export cone
Y-export cone
40
Effects of Increasing EK in Presence of Trade
Costs
SY
autarky
EK
X-export cone
Y-export cone
41
Effects of Increasing EK in Presence of Trade
Costs
TX, TY
autarky
TX
EK
TY
X-export cone
Y-export cone
42
Effects of Increasing EK in Presence of Trade
Costs
autarky
wK
wK
EK
wL
wL
EK
X-export cone
Y-export cone
43
Effects of Increasing PXw/PYw in Presence of
Trade Costs
SX,SY
autarky
SX
(?A PXA/PYA autarky price)
SY
?A
?w PXw/PYw
X-export cone
Y-export cone
44
Effects of Increasing PXw/PYw in Presence of
Trade Costs
DX,DY
autarky
DY
DX
?A
?w PXw/PYw
X-export cone
Y-export cone
45
Effects of Increasing PXw/PYw in Presence of
Trade Costs
TX,TY
autarky
TX
?w PXw/PYw
?A
TY
X-export cone
Y-export cone
46
Effects of Increasing PXw/PYw in Presence of
Trade Costs
wK/PY
autarky
wK/PY
?A
?w PXw/PYw
X-export cone
Y-export cone
47
Effects of Increasing PXw/PYw in Presence of
Trade Costs
wL/PY
autarky
wL/PY
?A
?w PXw/PYw
X-export cone
Y-export cone
48
Effects of Increasing Trade Costs

• As trade cost, t, rises from zero, Y-export cone
  and the X-export cone move further apart, and the
  autarky range of factor endowments and world
  prices gets larger
• For any given endowment and world prices, a rise
  in t reduces the volume of trade and moves other
  variables in the direction of their autarky
  values.

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Effects of Increasing Trade Costs

• Example
• Consider a country whose factor endowments have
  it completely specialized in good X at world
  prices

50
Effects of Increasing Trade Costs Example
SX,SY
autarky
SX
SY
t
X-export cone
51
The World Market The Textbook 222 H-O Model

• To model the world economy, add a second country
  (country )
• Solve for world (relative) price that clears the
  world market

52
The World Market The Textbook 222 H-O Model

• Results
• with analogous expressions for the other country

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The World Market The Textbook 222 H-O Model

• Depictions of world equilibrium
• Offer curves (Meade)
• Integrated-world-economy diagram (Dixit-Norman)
• Sufficient (but not elegant) to use supply and
  demand of just one of the goods

54
World Equilibrium
TX, -TX
TX
PX/PY
(PX/PY)w
-TX
(cone)
(cone)
55
Conclusions from the 22(2) H-O Model

• Equilibria are well defined
• Equilibrium quantities are unique
• Equilibrium prices are unique up to a numeraire

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Conclusions from the 22(2) H-O Model

• Includes three types of equilibria
• Autarky (when there are trade costs)
• Diversified
• Specialized
• Determinants of equilibrium type are mostly clear
• Several relationships between variables depend
  importantly on type of equilibrium

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Conclusions from the 22(2) H-O Model

• Classic Theorems are clear and precise
• Countries specialize, but only if endowment
  differences are large
• Prices and quantities vary continuously with
  exogenous changes in
• Endowments
• Trade costs
• In particular, trade responds sensibly to
• Prices and
• Trade costs

58
Whats Next?

• My point in the next lecture will be that some of
  these attractive properties are lost in higher
  dimensions i.e., especially when there are more
  than 2 of goods and countries