1. An Introduction to International Economics Second Edition
CHAPTER F O U R
An Introduction to International Economics Second Edition
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
An 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 nation’s relatively abundant (and therefore, cheap) factor and import the commodity whose production requires the intensive use of the nation’s 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
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. 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.

9. Factor price equalization
Exported commodities experience an increase in their price relative to the autarky situation.

10. 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.
At the same time, the return of the relatively scarce factor will fall.

11. 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.

12. 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.

13. 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.

14. 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.

15. Rybczinsky Theorem
At constant relative goods prices, a rise in the endowment of one factor will lead to a more than proportional expansion of the output in the sector which uses that factor intensively, and an absolute decline of the output of the other good.

16. Empirical tests of the H-O theory
The Leontief Paradox
A 1951 test of the H-O theory
Showed that the 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.

17. Capital Requirement
Labor Requirement
K/L
Exports
aKx =
aLx = man-years
14300$
Imports
aKm =
aLm = man-years
18200$
Swerling (1953) complained that 1947 was not a typical year: the postwar disorganization of production overseas was not corrected by that time.
In 1956 Leontief repeated the test for US imports and exports which prevailed in In his second study, Leontief aggregated industries into 192 industries. He found that US imports were still more capital-intensive than US exports.

18. Tatemoto and Ichimura (1959) studied Japan's trade pattern and discovered another paradox. Japan was a labor-abundant country, but exported capital-intensive goods and imported labor- intensive goods. Japan's overall trade pattern was inconsistent with HO.
Stolper and Roskamp (1961) applied Leontief's method to the trade pattern of East Germany. East Germany's exports were capital-intensive. About 3/4 of EG's trade was with the communist bloc, and EG was capital abundant relative to its trading partners. Thus, the EG case was consistent with the HO theory.

19. Hong (1975) analyzed Korea's trade pattern (1966-72), which was consistent with the HO theory.
Wahl (1961) studied Canada's trade pattern. Canadian exports were capital-intensive. Most of Canadian trade was with the US. The result was inconsistent with HO.
Bharawaj (1962) studied India's trade pattern. India's exports were labor-intensive. Consistent with HO theory.

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 tests 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. Reconciliations of the Leontief Paradox
U.S. workers are more productive than foreign workers (Leontief)
A realistic difference in effectiveness between the representative workers in the U.S. and those in the foreign countries were about 20-25%. Obviously, this difference does not explain the Leontief Paradox.

24. Reconciliations (cont.)
A third factor, natural resources, is not considered (Vanek)
U.S. tariffs on labor-intensive goods are high (Travis)
Baldwin (1971) showed that this indeed was the case. Without tariff, the capital-labor ratio of imports would have fallen by 5%, which is not sufficient to resolve the LP. The identical tastes assumption is violated
Leontief used data on U.S. import- competing goods

25. Reconciliations (cont.)
Factor Intensity Reversal
If a commodity is produced by a labor-intensive process in the labor-rich country and also by the capital-intensive process in the capital-rich country, then factor intensities are reversed in the production of that commodity.
Agriculture is labor-intensive in India but capital-intensive in US.
If the US imports agricultural products, then an LP occurs in the US, because a capital abundant country is importing the capital-intensive product.
If the US exports agricultural products, then an LP occurs in India, because a labor-abundant country, India, is importing the labor-intensive good.

26. Reconciliations (cont.)
Demand Bias
Research showed that it cannot explain the LP
Human Capital
Trade Imbalance

27. 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.

28. 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.

29. 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

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

31. 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.

32. 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.

33. 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.

34. 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.

35. 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

36. 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.

37. Transportation cost models of trade
Transportation costs
The introduction of transportation costs into the standard model of trade may eliminate a country’s 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.

38. 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

39. Environmental standards and trade
A nation’s environmental standards determine the level of acceptable pollution that may be generated from production.

40. Environmental standards and trade
A nation’s 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 country’s comparative advantage in production and alter the pattern of trade.

41. Environmental standards and trade
A nation’s 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.”

42. Environmental standards and trade
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