II. International Economics and Development

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II.International Economics and Development

• Raul Caruso
• Università Cattolica del Sacro Cuore di Milano
• raul.caruso_at_unicatt.it

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The Heckscher-Ohlin Model

• The HO model is also called the Factor
  Proportions Model.
• Developed by Eli Heckscher and BertilOhlin. It
  has been enriched by Paul Samuelson and Wolfang
  Stolper

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The Heckscher-Ohlin Model

• The Ricardian Idea of CA does not disappear.
  Comparative advantage is determined by
• (1)Factor endowments of countries
• (2)Factor intensities of industries

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The Heckscher-Ohlin Model

• 1.Countries differ in endowments of factors
• In its original formulation such differences
  relate to capital, land, labor, physical ad
  natural resources

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The Heckscher-Ohlin Model

• 2.Industries differ in factor intensities
• Consider different sectors. Mechanical industry
  use lots of capital. Agriculture uses lots of
  land. .etc..etc..

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Predictions of HO model

• (1) Countries tend to export goods whose
  production is intensive in factors with which
  they are abundantly endowed.
• (2) Owners of a countrys abundant factors gain
  from trade, but owners of a countrys scarce
  factor lose (there are winners and losers)
• (3) There is a convergence of factor prices.
  (factor prices equalization)

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Linking with CA

• Heckscher-Ohlin Theorem
• Countries have Comparative Advantage in, and
  (therefore) export, goods that use intensively
  the relatively abundant factors.

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The Heckscher-Ohlin Model

• There are two countries Home and Foreign.
• They both produce cloth and food.
• Home is labor-abudant and Foreign is
  land-abundant.

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Abundant Factors

• In order to verify which factor of production can
  be considered relatively abudant we start
  computing the ratio between the total supply of
  one factor and the total supply of the other
  factor. In our case

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Abundant Factors

• Then, making a comparison between two countries
  (Home and Foreign) we will say that the home
  country is relatively more abundant in labour if
  and only if

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Abudant Factors

• Consider that US has 80 million workers and 200
  million acres while UK has 20 million workers and
  20 million acres. Which country is
  labour-abundant?

Answer UK
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Abudant Factors

• Note that abundance is defined in terns of a
  ratio and not in absolute quantities. For
  example, If US has 80 million workers and 200
  million acres while UK has 20 million workers and
  20 million acres, we consider UK labour-abudant
  even if it has less total labour than US. In
  fact

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Costs and Prices

• If w is the hourly wage rate of labour and r is
  the cost of one acre of land, the relative cost
  can be expressed through

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Note

• We assume that relative prices depend upon
  relative costs. Then we have

.
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The Heckscher-Ohlin Model

• Note.
• As long as a country produces both goods there is
  a one-to-one relationship between the relative
  prices of good and the relative prices of factor
  used to produce the goods.

Relative abundance of a factor implies that its
relative cost is less than in countries where it
is relatively scarcer. Conversely, relatively
scarce resources are more expensive
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Before trade

• Before trade (autarky) we have that

Given that Home is a labor-intensive country.
That is in Home the relative price of clothes in
terms of food is lower than relative price in
foreign.
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Predictions of HO model

• Trade Leads to a Convergence of Relative Prices

The relative price of cloth rises in Home and
declines in Foreign and a new world price is
established at a point between the pretrade
relative prices.
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Predictions of HO model

• In Home the rise in relative price of cloth leads
  to a rise in the production of cloth and a
  decline of relative consumption. So home becomes
  an exporter of clothes and an importer of food.
  The decline in relative price of clothes in
  foreign leads it to become an importer of cloth
  and an exporter of food.

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Predictions of HO model

• In sum, the main result is that
• Countries tend to export goods whose production
  is intensive in factors with wich they are
  abundantly endowed.

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Distribution of income

• Following HO model, international trade has a
  powerful effect of income distribution. In Home
  country people who get their income from labour
  gain form trade but those who get their income
  from land are worse off. In foreign country the
  opposite happens Laborers are worse off and
  landowners are better off. That is, owners of an
  abudant factor gain from trade, but owners of a
  countrys scarce factors lose.

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Factor Price Equalization

• One of the most important prediction of HO model
  is that factor prices must converge.
• Is this true?
• In the real world factor prices are not equalized

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Factor Price Equalization

• Factor price equalization is based upon the
  convergence of relative prices. Since a
  convergence in relative price is predicted there
  must be also a convergence in factor prices. For
  example wages should equalize. A country
  exporting clothing should experience a rise in
  wage.

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Factor Price equalization
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Factor Price Equalization

• To check for the validity we have to discuss the
  assumptions
• (1) Both countries produce both goods
• (2) Identical technology
• (3) trade actually equalize the price of goods in
  the two countries
• (4) there is free movements of factors (in
  particular workers)
• (5) An implicit assumption is that countries have
  similar institutional regimes.

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Factor Price Equalization

• (1) Both countries produce both goods
• In other terms, this assumption can be
  generalized saying that countries have very
  similar factor endowments. Of course this is not
  always the case.

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Factor Price Equalization

• (2) Identical Technologies
• Techonology differs a lot between countries. A
  country with superior technology can have higher
  wages which are not converging. Recent works
  suggest that considering such differences would
  reconcile the HO model with actual data on world
  trade.

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Factor Price Equalization

• (3) trade actually equalize the price of goods in
  the two countries
• Prices differ. Some basic reasons are
• (i) natural barriers of trade
• (ii) Trade Policies (Tariffs, quotas and so on)
• (iii) existence of non-traded goods
• Note that these elements hold also for ricardian
  theory

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Factor Price Equalization

• (4) there is free movements of factors (in
  particular workers)
• Free movements of factors do not exist in
  reality. Pay particular attention to mobility of
  people. Restrictive immigration policies hinders
  the equalization of wages.

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Factor Price Equalization

• (5) An implicit assumption is that countries have
  similar institutional regimes.
• In particular, consider labour markets. Some
  countries have a more flexible labour market (USA
  for example). Other countries have sticky labour
  markets (european countries for example)

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North-South trade

• Although the overall pattern of international
  trade does not seem to fit the HO predictions,
  North-South trade in manufactures seem to fit the
  HO theory much better.
• HO model performs quite well when we analyse the
  patterns of trade of (i) labour-intensive goods
  and (ii) primary agricultural commodities.

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North-South trade

• It is common knowledge that NIE export
  labor-intensive manufactures (textile for
  example) to industrialized economies.
• Consider for example trade patterns between USA
  or EU and asian countries.

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In 2003 China imported Capital-Intensive Goods
from EU, USA and Japan and exported
labor-intensive goods
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• Departure from HO predictions and empirical
  evidence.

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Leontieffs Paradox (1953)
In 1953 Vassily Leontieff noted that US exports
were less capital-intensive than US imports.
According to the HO theory US would have been
expected to export more capital-intensive
goods. The possible explanation of Leontieffs
Paradox.. .is the presence
of High skilled work in USA. That is, Human
Capital was the abudant factor in USA.
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Leontieffs Paradox (1953)

• Leontieffs paradox suggests that when Human
  Capital is relatively abundant the country would
  export in particular goods emboding high levels
  of human capital (high-tech industry is the
  current example)
• Intuition As a measure of economic policy
  investiment in Human Capital today could lead to
  more exports tomorrow. This is also true in a
  Ricardian world.

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O Rourke and Williamson (1999)

• O Rourke and Williamson in 1999 published a work
  giving evidence that HO predictions about Factor
  Price equalization hold. The story is about the
  convergence of western economies between 1830 and
  1940.
• (i) there is evidence of convergence for real
  wages
• (ii) there is evidence of convergence of rental
  prices for land.

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Trefler (1995)

• In 1995 Trefler publishedd The case of the
  missing trade and other mysteries on AER.
  Trefler pointed out that the HO model predicts
  not only the direction but also the volume of
  trade. That is, the volume of trade between a
  labour abundant country and and a capital abudant
  country should be huge. Unfortunately for HO,
  volumes of trade were less than predicted.

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Trefler (1995)

• All data are from 1983 and there 33 countries
  considered accounting for 76 of world exports
  and 79 of world GNP.
• Nine factors are considered capital, cropland,
  pasture and six categories of labor (among them
  you find technical workers, agriculture workers,
  unskilled workers)
• Trefler claims that HO theorem is rejected
  because trade departs from its endowmwnt-based
  prediction in systemtic ways. Trade is Missing
  relative to its HO prediction.

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Trefler (1995)

• The final result of Trefler is that the HO
  prediction are rejected in favour of a
  modification that allows for (1) home bias in
  consumption home market effect and (2)
  international technology differences.

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Egger (2002)

• Egger (2002) unvoluntarily shows that differences
  in relative factor endowments also matter. This
  result partly follows HO predictions. He
  estimates a panel data for OECD and Central and
  Eastern European Countries. In particular, there
  is a positive association between differences in
  relative factor endowments and volume of trade.

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HO Models Legacy

• HO model applied to North-South trade perfoms
  quite good.
• Differences in factor endowment partly matter
  (Egger, 2002).
• we have an intuition about the relationshiop
  between trade and distribution of income.

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HO Models Unpredicted Legacy

• we understood that Human capital is a factor of
  production (thanks to Leontieff Paradox)
• Tecnological differences or similarities play a
  role (as in a Ricardian world)
• (3) We also understood that geography matters
  because size of countries affects trade patterns
  (home market effect)