Chapter 4 Resources and Trade: The Heckscher-Ohlin Model

1. Chapter 4 Resources and Trade: The Heckscher-Ohlin Model

2. Kernel of the Chapter • A Model of a Two-Factor Economy • Effects of International Trade Between Two-Factor Economies • Empirical Evidence on the Heckscher-Ohlin Model

3. Introduction • Trade also reflects differences in countries’ resources. • The Heckscher-Ohlin theory: • Resource differences as the only source of trade • Comparative advantage is influenced by: • Relative factor abundance (refers to countries) • Relative factor intensity (refers to goods)

4. A Model of a Two-Factor Economy • Assumptions of the Model • An economy can produce two goods, cloth and food. • The production of these goods requires two inputs that are in limited supply; labor (L) and land (T). • Production of food is land-intensive and production of cloth is labor-intensive in both countries. • Perfect competition prevails in all markets.

5. Unit land input aTF , in acres per calorie Input combinations that produce one calorie of food // Unit land input aLF , in hours per calorie A Model of a Two-Factor Economy Figure 4-1: Input Possibilities in Food Production

6. Factor Intensity In a world oftwo goods (cloth and food) and two factors (labor and land), food production is land-intensive, given wage-rental ratio the land-labor ratio TF/LF> TC/ LC Wage-rental ratio, w/r CC FF Land-labor ratio, T/L A Model of a Two-Factor Economy

7. A Model of a Two-Factor Economy • Factor Prices and Goods Prices • Stolper-Samuelson Theorem (effect): • If the relative price of a good increases, holding factor supplies constant, then the nominal and real return (in terms of both goods) to the factor used intensively in the production of that good increases, while the nominal and real return (in terms of both goods) to the other factor decreases.

8. Relative price of cloth, PC/PF SS Wage-rental ratio, w/r A Model of a Two-Factor Economy Figure 4-3: Factor Prices and Goods Prices

9. Wage-rental ratio, w/r CC FF (w/r)2 (w/r)1 SS Land- labor Ratio, T/L Relative price of cloth, PC/PF (PC/PF)1 (PC/PF)2 (TC/LC)1 (TF/LF)1 (TC/LC)2 (TF/LF)2 Increasing Increasing A Model of a Two-Factor Economy Figure 4-4: From Goods Prices to Input Choices

10. A Model of a Two-Factor Economy • An increase in the price of cloth relative to that of food, PC/PF ,will: • Raise w/r. • Raise T/L, in both cloth and food production • Raise the purchasing power of workers and lower the purchasing power of landowners

11. LF Labor used in food production OF Land used in cloth production C 1 TC TF Land used in food production F OC LC Labor used in cloth production Increasing Increasing Increasing Increasing A Model of a Two-Factor Economy • Resources and Output • How is the allocation of resources determined?

12. Labor used in food production O2F L1F L2F O1F Land used in cloth production T1C 1 T1F C T2C T2F Land used in food production 2 F1 F2 OC L1C Labor used in cloth production L2C Increasing Increasing Increasing Increasing A Model of a Two-Factor Economy • Rybczynski Theorem (effect):

13. Output of food, QF 2 Slope = -PC/PF Q2F Slope = -PC/PF Q1F 1 TT2 TT1 Output of cloth, QC Q2C Q1C A Model of a Two-Factor Economy Figure 4-7: Resources and Production Possibilities

14. Effects of International Trade Between Two-Factor Economies • Assumptions of the Heckscher-Ohlin model: • There are two countries (Home and Foreign) that have: • Sametastes • Sametechnology • Different resources • Home has a higher ratio of labor to land than Foreign does • Each country has the same production structure of a two-factor economy.

15. Effects of International Trade Between Two-Factor Economies • Relative Prices and the Pattern of Trade • Factor Abundance

16. Relative price of cloth, PC/PF RS* RS 3 2 1 RD Relative quality of cloth, QC + Q*C QF + Q*F Effects of International Trade Between Two-Factor Economies Figure 4-8: Trade Leads to a Convergence of Relative Prices

17. Effects of International Trade Between Two-Factor Economies • Heckscher-Ohlin Theorem: • A country will export that commodity which uses intensively its abundant factor and import that commodity which uses intensively its scarce factor.

18. Effects of International Trade Between Two-Factor Economies • Trade and the Distribution of Income • Trade produces a convergence of relative prices. • Changes in relative prices have strong effects on the relative earnings of labor and land in both countries: • Owners of a country’s abundant factors gain from trade, but owners of a country’s scarce factors lose.

19. Effects of International Trade Between Two-Factor Economies • Difference between the specific factors model and the Heckscher-Ohlin model in terms of income distribution effects

20. Effects of International Trade Between Two-Factor Economies • Factor Price Equalization • Factor-Price Equalization Theorem: • Trade leads to complete equalization in the relative and absolute returns to homogeneous factors across countries. • Trade is a substitute for the international mobility of factors. • Trade has reduced, rather than completely eliminated, the international difference in the returns to homogeneous factors.

21. Effects of International Trade Between Two-Factor Economies Table 4-1: Comparative International Wage Rates (United States = 100)

22. Effects of International Trade Between Two-Factor Economies • Three assumptions crucial to the prediction of factor price equalization are in reality untrue: • Both countries produce both goods • Both countries have the same technologies in production • Both countries have the same prices of goods due to trade

23. Effects of International Trade Between Two-Factor Economies Table 4-2: Composition of Developing-Country Exports (Percent of Total)

24. Empirical Evidence on the Heckscher-Ohlin Model • Testing the Heckscher-Ohlin Model • Tests on U.S. Data • Leontief paradox • Tests on Global Data • A study by Bowen, Leamer, and Sveikauskas tested the Heckscher-Ohlin model using data for a large number of countries.

25. Empirical Evidence on the Heckscher-Ohlin Model Table 4-3: Factor Content of U.S. Exports and Imports for 1962

26. Empirical Evidence on the Heckscher-Ohlin Model Table 4-4: Testing the Heckscher-Ohlin Model

27. Empirical Evidence on the Heckscher-Ohlin Model • Tests on North-South Trade • North-South trade in manufactures seems to fit the Heckscher-Ohlin theory much better than the overall pattern of international trade. • The Case of the Missing Trade • A study by Trefler in 1995 showed that technological differences across a sample of countries are very large.

28. Empirical Evidence on the Heckscher-Ohlin Model Table 4-5: Trade Between the United States and South Korea, 1992 (million dollars)

29. Empirical Evidence on the Heckscher-Ohlin Model Table 4-6: Estimated Technological Efficiency, 1983 (United States = 1)

30. Empirical Evidence on the Heckscher-Ohlin Model • Implications of the Tests • Empirical evidence on the Heckscher-Ohlin model has led to the following conclusions: • Less successful at explaining the actual pattern of international trade. • Useful as a way to analyze the effects of trade on income distribution.