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