International Trade Theory (1/2008) Chulalongkorn University Lecture 5 the Heckscher-Ohlin Model (part II) Kornkarun Cheewatrakoolpong, Ph.D.

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1 Internatonal rade heory (1/2008) Chulalongkorn Unversty ecture 5 the Heckscher-Ohln Model (part II) ornkarun Cheeatrakoolpong, Ph.D. he logc - ake { a1, a1, a2, a2} as constant and manpulate the full employment condtons to get Rybcznsk theorem. - Use property of dentcal homothetc tastes plus Rybcznsk theorem to get Heckscher-Ohln theorem. - Use propertes of unt cost functon and common orld prces to get factor prce equalzaton theorem. - Use property of unt cost functon to sho the Stolper-Samuelson theorem. - Use applcatons and emprcal evdence to sho you the model at ork. Rybcznsk heorem (revsted) e combne the Rybcznsk theorem th our assumptons on tastes to generate the Hckscher-Ohln theorem. p 1 1/ p P y / y e kno that snce good 1 are labor ntensve, e must have : ( ) < ( ) < ( ) * 2. If = λ for λ > 0 * = λ Country sze has no effect on comparatve advantage. Suppose that there are to countres: US and haland. he US s captal abundant relatve to haland. here are to goods: Automobles and rce. Automobles are captal ntensve and rce s labor-ntensve.

2 P A / P R US P A U B (A/S) hat e can see from graph? 1. US s captal abundant relatve to haland snce US s further to the rght comparng th. 2. Autarky relatve prce n haland s hgher than n US. herefore, US has comparatve advantage n automobles hle haland has comparatve advantage n rce. (Note that prce s equal to unt cost because of perfect competton assumpton). 3. 1) + 2) captal abundant country has comparatve advantage n the captal ntensve good and labor abundant country has comparatve advantage n labor-ntensve good. 4. After trade, everyone consumes the rato (A/S) from dentcal preference and orld prces. he orld as a hole produces n ths rato. But US produces at pont B and haland produces at pont A. Consumpton ratos converge; Producton ratos dverge. US exports automobles hle haland exports rce. Heckscher-Ohln heorem Assume countres have dentcal technologes and tastes; there are no barrers to trade, then the captal abundant country exports the captal ntensve goods and the labor abundant country exports the labor ntensve good. A/R Relatve factor endoments + Intensty dfferences rade patterns In addton to establshng the trade pattern, the HO model has precse mplcatons for ho gans and ho loses from trade. In summary, the abundant factor n each country gans from trade, and the scarce factor loses. he result follos from

3 the pattern of prce changes and the Stolper-Samuelson theorem. After trade, A A P < P < PUS. Usng the Stolper-Samuelson, ths s smlar to, for haland, the prce of rce ncreases. As a result, accordng to the Stolper-Samuelson theorem, the rental prce ncreases and the oners of captal are better off hle age decreases and labors are orse off. For the US, the prce of automobles ncreases. herefore, age ncreases and rental prce decreases. abors are better off hle the captal oners are orse off. Notce that labor s the abundant factor at haland. he fact that US ( ) > ( ) means that labor ould have been earnng less n haland autarky than the US autarky.from concavty of the producton functon, MP of haland < MP of the US for both goods. Hoever, th free trade, haland can shft producton toard labor-ntensve good and export t; therefore absorbng the abundant factor thout loerng ts age. As a result, factor prces are equalzed n the to countres after trade hch s stated n factor prce equalzaton theorem. So the abundant factor ll gan from trade hle the scarce factor loses. Intuton: - One country has lot of one factor relatve to the other. hs tends to make the factor cheap. - You cannot trade factors drectly so you use the relatvely cheap factor to make the good usng the cheap factor. - Internatonal trade n goods s a roundabout ay to trade n servce of factors. (Remnder: hese countres have the same tastes and technologes). Notes: In HO theorem, specalzaton and dversfcaton do not matter for the predctons on trade patterns. hy? 1. In autarky, you have to produce both good s yourself so prces of both goods adjust to ensure that you are dversfed. (Of course unless you have nonconvex preferences). 2. In trade, f you do specalze n the producton of one good, t s alays the good that uses your abundant factor ntensvely. hs mples that you must export t and mport the good usng your scarce factor ntensvely hch s just hat you see n the HO theorem. hy s 2) true? Reconsder our US-haland example. Focus on haland. Japan has comparatve US advantage n rce because rce s labor ntensve and e assume that ( ) > ( )

4 P / P A US A U B R/A (R/A) A Movng from autarky to trade, P > P for Japan. hs means that f they specalze, t ould have been n rce, ts comparatve advantage good. If they do, you stll get the HO theorem. In summary, f haland or/and US specalze, t ould not made any dfference to trade pattern predctons from the HO theorem. HO s easly to be emprcally tested. For example, haland s labor abundant so t should export labor-ntensve good and so on. Hoever, t turns out that the HO model s a rather poor predctor of actual trade patterns, ndcatng that ts assumptons are not realstc. Hoever, t has taken many years to understand hy ths s the case. e begn the exploraton by consderng the earlest results by eontf (1953) of hat e call eontef s paradox. eontef s Paradox eontef (1953) as the frst attempt to emprcally test the HO model th data. He developed the set of nput-output accounts for the US economy to compute the amounts of labor and captal used n each ndustry for In addton, he utlzed US trade data for the same year to copute the amount of labor and captal used n the producton of $1 mllon of US exports and mports Export Import Captal ($ mllons) abor (persons) Captal/ labor 13,700 18,200 Snce there s no knoledge of the foregn technology, eontef smply used the US technology to calculate the amount of labor and captal used n mports hch should be true to valdate the test of the HO model snce an assumpton of the HO model s that technologes are the same across countres. he result as shon n the table s that the captal-labor rato n Foregn export s remarkably hgh comparng th US exports. Hoever, US s captal abundant

5 country. herefore, the results contradct the HO theorem hch s hat e called the eontf s paradox. here are de ranges of the explanatons for ths paradox: 1. US and Foregn technologes are not the same. 2. eontef gnored land. 3. abor should have been dsaggregated by skll (snce US exports mght be concentrated on the sklled labor ntensve). 4. Data for 1947 may be unusual (the end of II) 5. US as not engaged n free trade. Couples of years later, many research try to redo the analyss takng nto account land, sklled and unsklled labor and so on. he general concluson s that the paradox contnues to occur n some cases untl to decades later. eamer (1980) provded crtque of the eontef s paradox that actually eontef performed the rong test! He should not compare captal/labor ratos n export and mport but should perform the test relyng on the factor content verson of the HO model, developed by Vanek (1968), nstead. Heckscher-Ohln-Vanek (HOV) Model Consder many countres =1,,C, many ndustres j=1,..,n and many factors k,l = 1,,M. Assumptons: 1. Identcal technologes 2. Factor prce equalzaton holds 3. tastes are homothetc and dentcal et (MxN) matrx A = [ a jk ]' denote the amount of factor needed for one unt of producton n each ndustry. Ros measures dfferent factors and columns measure dfferent goods. a 1 a2 A = a1 a2 Y = (nx1) vector of outputs n each ndustry for country D = (nx1) vector of demands n each ndustry for each good = Y D s the net export for country he factor content of trade s then defned as: F = A hch s (Mx1) vector th ndvdual components Fk > 0 f factor s exported and Fk < 0 f factor s mported. Suppose that there are to factors, labor and captal, then F l A = Fk No A = AY AD th AY s the demand for factors n Country I and from the full employment condton. AY = V the endoments of Country Next, consder AD, from dentcal and homothetc preferences, the consumpton vector must be proportonal to each other.

6 D = S D D = orld consumpton S = share of Country n the orld consumpton = share of Country of the orld GDP AD = S AD = S AY = S V (1) (1) s hat e call HOV theorem. If country s endoment of factor k relatve to the orld endoment exceeds country s share of orld GDP, V k > S, then country Vk s abundant n that factor. No f e consder the trade balance, each country s expendture equals ts factor ncome. hen S s share of country s n the orld factor endoment. If a country s endomed th more than ts share of a partcular factor, then t ll be not exporter of the servces of that factor. hs s hat eontef uses to perform hs test and go eontef s paradox. US s captal abundant and labor scarce relatve to the rest of the orld so t should embody more captal n ts exports than n ts mport and less labor. Hoever, as e sa last tme, the result contradcts ths presumpton hch brngs about the famous eontef s paradox. An mportant step toard resolvng eontef s paradox s done by eamer (1980) ho noted that the US has trade surplus n 1947 hch contradcts the HOV assumpton. herefore, the US n eontef s data as actually a net exporter of both captal and labor servces. et us focus on just to elements of the factor content vectors, labor and captal. F = S (2) F k l = S e defne captal to be abundant relatve to labor n country f then from (2), = ( Fk ) / S = ( Fl ) / S herefore, = herefore, No S F S = F > mples that > Fk Fl and l k > are smply the endoments of captal and labor or the captal and labor emboded n producton. If e subtract the content of factors emboded n trade, then e end up th the factor content of consumpton. herefore, (3) states that captal abundant should be tested by captal/labor rato of producton exceedng the captal/labor rato emboded n consumpton. (3)

7 heorem (eamer 1980) HOV theorem (1) mples that captal / labor rato emboded n producton for country exceeds the rato emboded n consumpton. eamer makes ths comparson for the US n 1947 and got the follong table. Producton Consumpton Captal ($ bllons) abor (mllons person/year) Captal/ labor ($/person) 6,949 6,737 herefore, there s no paradox after all.