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The Heckscher-Ohlin Model: Features, Flaws, and Fixes I: What's the H-O Model Like?

The Heckscher-Ohlin Model: Features, Flaws, and Fixes I: What's the H-O Model Like?. Alan V. Deardorff University of Michigan. Themes of the 3 Lectures. The HO Model is largely well behaved in 2 dimensions, even when you include trade costs

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The Heckscher-Ohlin Model: Features, Flaws, and Fixes I: What's the H-O Model Like?

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  1. The Heckscher-Ohlin Model: Features, Flaws, and FixesI: What's the H-O ModelLike? Alan V. Deardorff University of Michigan

  2. Themes of the 3 Lectures • The HO Model is largely well behaved in 2 dimensions, even when you include trade costs • In higher dimensions, it is not so well behaved, especially when you include trade costs • Various modifications and extensions of the HO model offer some promise of making it behave better Nottingham I

  3. Outline of Lecture I • Overview of the H-O Model • The 2×2 Model • Without trade costs • With trade costs • The 2×2×2 Model • Conclusions from the 2×2(×2) Model Nottingham I

  4. H-O Overview • The Heckscher-Ohlin (H-O) Model Assumptions • Homogeneous goods and factors • Perfectly competitive market equilibrium throughout (goods and factors) • Production functions • Constant returns to scale • Non-joint • Factors • Perfectly mobile across industries • Perfectly immobile across countries • Countries differ in factor endowments • Industries differ in factor intensities Nottingham I

  5. H-O Overview • The Heckscher-Ohlin (H-O) Model Implications • Countries export goods that use intensively their abundant factors (H-O Thm) • Trade draws factor prices closer together across countries, becoming equal in certain circumstances (FPE Thm) • Trade changes real factor prices (S-S Thm) • Benefiting owners of abundant factors • Hurting owners of scarce factors • Rybczynski Thm (output effects of factor accumulation) Nottingham I

  6. The Textbook 2×2 H-O Model • Goods X, Y • Factors K, L • X is K-intensive • Goods are final goods • Trade is • Free and frictionless, or • Subject to simple, constant trade costs per unit (perhaps “iceberg”) Nottingham I

  7. The Textbook 2×2 H-O Model • Analysis: Expanded Lerner Diagram shows • Production • Factor allocations • Factor Prices • Trade for given • Goods prices • Factor endowments • Thus • Full solution for small open economy • Dependence on prices for large economy Nottingham I

  8. Lerner Diagram K X=1/PX0 1/wK0 Y=1/PY0 1/wL0 L Nottingham I

  9. Lerner Diagram K E0 X0 X=1/PX0 1/wK0 Y=1/PY0 Y0 1/wL0 L Nottingham I

  10. Lerner Diagram Export K E0 X0 EC = EW X=1/PX0 XC 1/wK0 YC Y=1/PY0 Y0 Import 1/wL0 L Nottingham I

  11. The Textbook 2×2 H-O Model • Behavior • If Endowments inside Diversification Cone • Both goods produced • Factor prices independent of endowments • If Endowments outside Diversification Cone • One good produced • Factor prices depend on endowments Nottingham I

  12. The Textbook 2×2 H-O Model • Sensitivity • All variables (outputs, trade, factor prices) are uniquely determined and depend smoothly on • Endowments • Prices • Adding trade costs vis a vis a single other country • Creates range of world prices for which country does not trade • Outside that range, all variables depend smoothly on trade costs Nottingham I

  13. The Textbook 2×2 H-O Model • Summary • With free and frictionless trade: Nottingham I

  14. The Textbook 2×2 H-O Model • Summary • With iceberg trade costs, t: Nottingham I

  15. Effects of Increasing Capital Endowment, EK K EK X=1/PX0 1/wK0 cone Y=1/PY0 1/wL0 L Nottingham I

  16. Effects of Increasing EK SX SX Rybczynski Thm: SX/EK, rises with EK EK cone Nottingham I

  17. Effects of Increasing EK SY Rybczynski Thm: SY Falls with EK SY EK cone Nottingham I

  18. Effects of Increasing EK DX, DY DX DY EK cone Nottingham I

  19. Effects of Increasing EK TX, TY TX EK TY cone Nottingham I

  20. Effects of Increasing EK wK wK0 wK EK wL wL wL0 EK cone Nottingham I

  21. Effects of Increasing Labor Endowment, EL K X=1/PX0 1/wK0 Effects are mirror image of increasing EK EL Y=1/PY0 1/wL0 L Nottingham I

  22. Effects of Increasing Price of X, PX K X=1/PX0 1/wK0 Y=1/PY0 1/wL0 L Nottingham I

  23. Effects of Increasing Price of X, PX K X=1/PX0 1/wK0 Y=1/PY0 1/wL0 L Nottingham I

  24. Effects of Increasing Price of X, PX K X=1/PX0 1/wK0 Y=1/PY0 1/wL0 L Nottingham I

  25. Effects of Increasing Price of X, PX SX SX PX (cone) Nottingham I

  26. Effects of Increasing Price of X, PX SY SY PX (cone) Nottingham I

  27. Effects of Increasing Price of X, PX DX, DY DY DX PX (cone) Nottingham I

  28. Effects of Increasing Price of X, PX TX, TY TX PX TY (cone) Nottingham I

  29. Effects of Increasing Price of X, PX wK wK Stolper-Samuelson Thm: wK/PX, wK/PY rise with PX PX (cone) Nottingham I

  30. Effects of Increasing Price of X, PX Stolper-Samuelson Thm: wL/PX, wL/PY fall with PX wL wL PX (cone) Nottingham I

  31. Effects of Increasing Price of Y, PY • Effects are mirror image of increasing PX Nottingham I

  32. Effects of Presence of Trade Costs • Assume iceberg trade cost t−1>0, equals fraction of each good that disappears in transit to world market (must ship t for 1 to arrive) • Implication for domestic prices if world prices are PXw, PYw: • If country exports X: PX=PXw/t; PY=tPYw • If country exports Y: PY=PYw/t; PX=tPXw • If country does not trade: (PXw/PYw)/t2≤ PX/PY≤ t2(PXw/PYw) Nottingham I

  33. Presence of Trade Costs K EC X=1/PXw 1/wKw Y=1/PYw 1/wLw L Nottingham I

  34. Presence of Trade Costs If country exports X K …which it will if endowment is above this line ECX EC X=1/PXw 1/wKw Y=1/PYw 1/wLw L Nottingham I

  35. Presence of Trade Costs K EC X=1/PXw ECY 1/wKw If country exports Y …which it will if endowment is below this line Y=1/PYw 1/wLw L Nottingham I

  36. Presence of Trade Costs If country exports X K autarky ECX EC X=1/PXw ECY 1/wKw If country exports Y Y=1/PYw 1/wLw L Nottingham I

  37. Effects of Increasing EK in Presence of Trade Costs If country exports X K autarky ECX EC X=1/PXw ECY 1/wKw If country exports Y Y=1/PYw 1/wLw L Nottingham I

  38. Effects of Increasing EK in Presence of Trade Costs PX/PY autarky t2PXw/PYw PXw/PYwt2 EK Y-export cone X-export cone Nottingham I

  39. Effects of Increasing EK in Presence of Trade Costs SX autarky EK Y-export cone X-export cone Nottingham I

  40. Effects of Increasing EK in Presence of Trade Costs SY autarky EK Y-export cone X-export cone Nottingham I

  41. Effects of Increasing EK in Presence of Trade Costs TX, TY autarky TX EK TY Y-export cone X-export cone Nottingham I

  42. Effects of Increasing EK in Presence of Trade Costs autarky wK wK EK wL wL EK Y-export cone X-export cone Nottingham I

  43. Effects of Increasing PXw/PYwin Presence of Trade Costs SX,SY autarky SX (ρA =PXA/PYA = autarky price) SY ρA ρw =PXw/PYw Y-export cone X-export cone Nottingham I

  44. Effects of Increasing PXw/PYwin Presence of Trade Costs DX,DY autarky DY DX ρA ρw =PXw/PYw Y-export cone X-export cone Nottingham I

  45. Effects of Increasing PXw/PYwin Presence of Trade Costs TX,TY autarky TX ρA ρw =PXw/PYw TY Y-export cone X-export cone Nottingham I

  46. Effects of Increasing PXw/PYwin Presence of Trade Costs wK/PY autarky wK/PY ρA ρw =PXw/PYw Y-export cone X-export cone Nottingham I

  47. Effects of Increasing PXw/PYwin Presence of Trade Costs wL/PY autarky wL/PY ρA ρw =PXw/PYw Y-export cone X-export cone Nottingham I

  48. Effects of Increasing Trade Costs • As trade cost, t, rises from zero, Y-export cone and the X-export cone move further apart, and the “autarky” range of factor endowments and world prices gets larger • For any given endowment and world prices, a rise in t reduces the volume of trade and moves other variables in the direction of their autarky values. Nottingham I

  49. Effects of Increasing Trade Costs • Example: • Consider a country whose factor endowments have it completely specialized in good X at world prices Nottingham I

  50. Effects of Increasing Trade Costs: Example SX,SY autarky SX SY t X-export cone Nottingham I

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