Factors mobile

1. Factors mobile According to H-O Model, if factors could move freely, for example, labor would migrate from low income China to high income USA and wages would become equal internationally. The opposite would happen to capital cost which would migrate from the USA to China. Is this really happening?

2. The Factor Equalization theorem in H-O. American capital “runs” to China USA CHINA Less cheap C C Less expensive L L Less expensive Less cheap China labor “runs” to the USA LABOR: only few underpaid Chinese can come and work in the USA legally. CAPITAL: Americans prefer to invest in the USA not in China.

3. The Factor Equalization theorem in H-O. Barriers to free capital movement USA CHINA C cheap C expensive cheap L L expensive Barriers to free labor movement

4. The factor equalization theorem: • What is then happening since a massive factor migration is not possible? • Trade becomes a substitute for the factor migration…. • China exports labor - intensive goods and the USA capital - intensive goods.

5. The Stopler - Samuelson theorem • The S-S Theorem looks at the welfare aspects of the factors of production in capital and labor intensive industries. • Countries have comparative advantage in goods which they use intensely relatively abundant factors of production (the H-O conclusion). If China has abundant and cheap labor they should export vegetables, textiles, furniture because it needs less capital and more labor.

6. The Stopler-Samuelson theorem USA USA Exports capital intensive goods CHINA • MORE • CAPITAL • CHEAPER • CAPITAL • LESS CAPITAL • EXPENSIVE • CAPITAL C C L L China Exports labor intensive goods

7. USA CHINA Cheap capital becomes expensive because of extensive use in exports Expensive capital becomes cheaper because of less use in exports USA Exports capital intensive goods C C L L PK up PK down China Exports labor intensive goods

8. USA CHINA USA Exports capital intensive goods PK down PK up C C L L Expensive labor becomes cheap because of small use Cheap labor becomes expensive because of extensive use China Exports labor intensive goods PL down PL up

9. The Factor Equalization theorem in SS. Workers gain USA CHINA PRICES BECOME EQUAL Workers loose C C L L Workers loose Workers gain In the USA workers in Capital intensive industries GAIN, and in Labor intensive LOSE; In China workers in Capital intensive industries LOSE, and in Labor intensive industries GAIN.

10. PX/PY (PX/PY)US (PX/PY)China (w/r)US w/r (w/r)China Proof for Factor Equalization theorem X: Labor-intensive good Y: Capital-intensive good

11. Cloth • 600 M Capital Constraint J’ 300 E’ 240 J 225 • E • 150 Labor constraint • G G’ H • • 0 Steel 150 125 200 450 Rybczyski Theorem • In a two-good country with constant prices, if the endowment of one factor of production increases, while the amount of the other factor remains unchanged, the output of the good that is intensive in the growing factor increases, and the output of the other good decreases.

12. Case Study:“Dutch Disease” • When the Netherlands developed natural gas fields under the North Sea in 1970s, a lot resources of the country were attracted to this industry. So that the manufacturing sector suffered. Similar problems happened in Britain, Norway, Australia, and Mexico. This case is usually called”Dutch Disease” • Reason: • resources were attracted to gas industry because of higher profits • Export of natural resource ——appreciation——foreign demand for traditional exports reduced .

13. C B A Edgeworth Box Diagram(for one country)

14. B country A country Edgeworth Box Diagram(for two countries)

15. Testing the H-O model • Empirical evidence on H-O model • Leontief Paradox • Explanation to Leontief Paradox • Factor-intensity reversal • Human capital • Demand preference • Tariff disturbance • Natural resources • Summary

16. Empirical Evidence on the H-O Model Comparative International Wage Rates (United States = 100)

17. Empirical Evidence on the H-O Model Trade Between the United States and South Korea, 1992 (million dollars)

18. 1899 Whitney 1947 Leontief 182 170 1958 Bowen 131 119 Classical Test Results

19. Leontief Paradox • One would expect that US would be an exporter of capital-intensive goods and an importer of labor-intensive goods. Surprisingly,this was not the case after World War II. • In 1953,the economist W.Leontief found that US exports are less capital-intensive than imports. This result is know as the Leontief Paradox. • A study by Bowen, Leamer, and Sveikauskas (1987), which uses data for a large number of countries, confirms the Leontief paradox on a broader level

20. Factor Content of U.S. Exports and Imports for 1962

21. Factor-intensity Reversal • H-O model assume identical technologies between countries, that’s to say, the same good has the same factor-intensity. • In fact, due to the difference in factors endowments and technology levels, this assumption is far from reality. • For example, Food is labor-intensive in China, but capital-intensive in US. • So factor-intensity reversal is the main reason that agricultural products are regarded as labor-intensive good in US.

22. Homogeneity of factors & Human Capital • H-O theorem assume the same kind of factors are homogeneous among different countries. • In fact, no matter natural resources, labor or capital are heterogeneous among different countries.

23. Homogeneity of factors & Human Capital • Leontief argued that the most abundant resources in US are not capital, but skilled peasants and scientific and technological labors. They are not labors in common sense, but Human Capital。 • It is agricultural products which are classified as labor-intensive goods, and technology-intensive goods that US export in large numbers.

24. Demand Preference • H-O theorem assume the same consumer preference in different countries. This assumption is sometimes not true. • Case study China:prefer to rice(labor-intensive) labor abundant US: prefer to bike(capital-intensive) capital abundant Result:China import rice;US import bike.

25. D C bike B A US China rice

26. Barriers Disturbance • H-O model assume no trade barriers. • In fact, trade barriers exist more or less, such as tariff. • Tariff and other trade barriers will distort the market, and make H-O theorem invalid. Trade barriers’ effect on trade will be discussed in later chapters.

27. Natural resource • Leontief just calculated two factors, labor and capital. • In fact natural resource has very large proportions in US’s imports. • Natural resource-intensive products were regarded as capital-intensive products, which lead to the so called “paradox”

28. Summary for Leontief Paradox • Leontief Paradox is the very first empirical tests with statistical data on IT theory. • Leontief Paradox stemmed from the too strict assumptions far from reality in H-O theorem. Especially after World War II, the gap between reality and neoclassical model in IT become wider and wider, which call for the birth of modern international trade theories. • The explanations for Leontief Paradox suggest that there are many elements affecting IT.

29. Summary for H-O model • H-O model interpret the role of resource in trade:Country tend to export goods that are intensity in the factor with which they are abundantly supplied. • Key Terms: • Factor Endowment(abundant&scarce) • Factor intensity • Leontief Paradox