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.
1
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.
2
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
3
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.
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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.
5
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.
6
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.
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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.
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Factor price equalization
 Exported commodities experience an
increase in their price relative to the autarky
situation.
9
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.
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.
 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.
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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.
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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.
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.
 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.
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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.
15
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.
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Capital
Requirement
Labor Requirement
K/L
Exports
aKx = 2.550780
aLx = 182.313 man-years
14300$
Imports
aKm = 3.091339
aLm = 170.114 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 1951. In his second study,
Leontief aggregated industries into 192 industries. He
found that US imports were still more capital-intensive
than US exports.
4 - 17
 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 laborintensive 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.
4 - 18
 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.
4 - 19
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.
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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.
21
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.
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Reconciliations
of the Leontief Paradox
 U.S. workers are more productive than
foreign workers (Leontief)

4 - 23
A realistic difference in effectiveness between
the representative workers in the U.S. and
those in the foreign countries were about 2025%. Obviously, this difference does not
explain the Leontief Paradox.
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
4 - 24
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 capitalintensive 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
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Reconciliations (cont.)
 Demand Bias

Research showed that it cannot explain the LP
 Human Capital
 Trade Imbalance
26
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.
27
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.
28
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
29
Product differentiation based trade
 Differentiated products
 Intra-industry trade may arise from product
differentiation.

Intra-industry trade is international trade in
differentiated products.
30
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.
31
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.
32
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.
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.
 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.
34
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
35
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.
36
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.
37
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
38
Environmental standards and trade
 A nation’s environmental standards
determine the level of acceptable pollution
that may be generated from production.
39
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.
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.
 In order to maintain comparative advantage,
a nation may reduce its environmental
protections.

This may spur a “race to the bottom.”
41
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
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