HO and Factor Price Equalization

Does Heckscher – Ohlin explain trade patterns? To test HO we need data on: Factor endowments for each country Factor proportions used in the production of different goods (Factor Intensity) Data on trade patterns of goods produced

First test: wassily Leontif (1954) At the time the US was widely believed to be Kabundant & Lscarce : Were we? HO predicts: US should export Kintensive goods & import Lintensive goods. Leontif tested the proposition by analyzing the K/L ratio for US 200 export and import industries using 1947 trade data. Define: 𝐾 𝐿 𝑒𝑥𝑝𝑜𝑟𝑡𝑠 = factor ratio of US exports Define: 𝐾 𝐿 𝑖𝑚𝑝𝑜𝑟𝑡𝑠 = factor ratio for US imports If US exports are Kabundant then: HO suggests we should see: 𝐾 𝐿 𝑒𝑥𝑝𝑜𝑟𝑡𝑠 > 𝐾 𝐿 𝑖𝑚𝑝𝑜𝑟𝑡𝑠 → 𝐾 𝐿 𝑖𝑚𝑝𝑜𝑟𝑡𝑠 𝐾 𝐿 𝑒𝑥𝑝𝑜𝑟𝑡𝑠 < 1

Leontief Paradox HO suggests we should see: 𝐾 𝐿 𝑒𝑥𝑝𝑜𝑟𝑡𝑠 > 𝐾 𝐿 𝑖𝑚𝑝𝑜𝑟𝑡𝑠 Instead: 𝐾 𝐿 𝑒𝑥𝑝𝑜𝑟𝑡𝑠 = $14,015 < 𝐾 𝐿 𝑖𝑚𝑝𝑜𝑟𝑡𝑠 =$18,184 𝐾 𝐿 𝑖𝑚𝑝𝑜𝑟𝑡𝑠 𝐾 𝐿 𝑒𝑥𝑝𝑜𝑟𝑡𝑠 = $18,184 $14,015 =1.30→𝑈𝑆 𝑖𝑚𝑝𝑜𝑟𝑡𝑠 𝑎𝑟𝑒 30% 𝑚𝑜𝑟𝑒 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑡𝑒𝑛𝑠𝑖𝑣𝑒 𝑡ℎ𝑎𝑛 𝑈𝑆 𝑒𝑥𝑝𝑜𝑟𝑡𝑠

Why are US exports less capital intensive Wide rage of explanations Countries may differ in technology: US and foreign technologies are not the same By focusing on L and K, Leontief ignored land abundance in the US. Leontief should have distinguished between skilled and unskilled labor. 1947 data may have been weird because WWII just ended two years prior. US trade was not completely free (also assumed by HO – though we did not emphasize it).

What do we know? Thus it is most simple version, HO models does a poor job of explaining overall trade patterns (especially for mfg goods) What about factor endowments? HO assumes: countries differ in factor endowments Why? We want to know the relative abundance/scarcity of a factor within a country Definition of Factor Abundant: When a country’s world share of a factor is larger than its world share of GDP Definition of Factor Scarce: When a country’s world share of a factor share is less than its world share of GDP

Differences in factor endowments (2010) F&T International Trade 2nd edition p. 101 Robert C. Feenstra and Alan M. Taylor International Trade, Third Edition / International Economics, Third Edition Copyright © 2014 by Worth Publishers

Hmmmm….. These results causes us to wonder whether an R&D scientist or unit of capital has the same productivity across all countries Recall HO assumes same technology Leontief, himself, suggested abandoning HO assumption of same technology Recall Leontief found: US exported labor intensive goods What if: labor may be more productive in the US (and less productive in the ROW). How to calculate “effective labor force” Effective labor: = labor force x productivity productivity = how much output the factor can produce with one unit of labor Effective factor endowment = actual factor endowment x factor productivity Effective R&D scientist = actual R&D scientist endowment x R&D spending per scientist Effective labor = population x wages

Differences in effective factor endowments (2010) F&T International Trade 2nd edition p. 101 Robert C. Feenstra and Alan M. Taylor International Trade, Third Edition / International Economics, Third Edition Copyright © 2014 by Worth Publishers

U.S. Food Trade and Total Agricultural Trade, 2000-2012 Table 4.2 U.S. Food Trade and Total Agricultural Trade, 2000–2009 Feenstra and Taylor: International Trade, Second Edition Copyright © 2011 by Worth Publishers

Labor Endowment and GDP for the U.S. and Rest of the World, 1947 Leontif Paradox again with effective labor: Consider US labor abundance (1947 again). Labor = US population in each country (rough measure of labor force) Effective Labor = US population x wages (rough estimate of worker productivity) US had 43% of the world’s effective labor as compared to 37% of world GDP US was abundant in effective labor. HO predicts US should produce and exports labor intensive goods Robert C. Feenstra and Alan M. Taylor International Trade, Third Edition / International Economics, Third Edition Copyright © 2014 by Worth Publishers

Factor Price Equalization – does it hold? Index of hourly compensation cost for manufacturing workers in 2012, US = 100 Norway 178 Sweden 140 Germany 128 France 112 Canada 103 United Kingdom 88 Greece 54 Brazil 31 Mexico 18 Philippines 6 Why persistent differences in factor prices? Income inequality (wage differences) across countries results from uneven ownership of human capital. HO assumes all labor is identical, but labor across countries differs in terms of human capital: educ., training, skill. HO assumes all countries use the same technology. This does not hold – especially between developed and developing countries Thus returns paid to resource owners will not equalize if technology for producing goods differ Machinery workers in Germany use superior production technologies than Vietnamese workers HO assumes no transportation costs and trade barriers when in fact they are quite prevalent Market imperfections reduce the volume of trade, limiting the extent to which product prices and thus factor prices can equalize. https://www.bls.gov/fls/ichcc.pdf US Bureau of Labor Statistics