IT- 04- HO model international Trade

8/19/2019 IT- 04- HO model international Trade

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Resources and Trade:Resources and Trade:The Heckscher-Ohlin ModelThe Heckscher-Ohlin Model


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Introduction

Trade is explained by

• differences in labor productivity,

• differences in countries resources!

The Heckscher-Ohlin theory:

• "#phasi$es resource differences as the only source oftrade

• %ho&s that co#parative advanta'e is influenced by: ( Relative factor abundance )refers to countries* ( Relative factor intensity )refers to 'oods*

• Referred to as the factor-proportions theory


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+ssu#ptions of the Model

• T&o 'oods- cloth and food!

• T&o inputs - labor ) L* and capital ) K *!

• roduction of food is capital-intensive and

production of cloth is labor-intensive in bothcountries!

• erfect co#petition prevails in all #arkets!

+ Model of a T&o-actor "cono#y


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rices and roduction


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roduction ossibility rontier

.ithout actor %ubstitution %uppose, the capital

constraint is,

The labour constraint is,


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roduction ossibility rontier .ith

actor %ubstitution

The value of the

econo#ys

production is


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.here does the econo#y produce/

"0uilibriu#:

The opportunity cost in

ter#s of food of

producin' another

unit of cloth is e0ual

to the relative priceof cloth


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//

Input combinations

that produce one

calorie of food

Unit capital input aKF,

in acres per calorie

Unit labour input aLF,

in hours per calorie


Input ossibilities in ood roduction


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• Factor Intensity ( In a &orld of t&o 'oods )cloth and food* and t&o factors

)labor and capital*, food production is capital-intensive, if

at any 'iven &a'e-rental ratio the capital-labor ratio used in

the production of food is 'reater than that used in the

production of cloth:

K F 1 L F 2 K C 1 LC ( "xa#ple: If food production uses 34 &orkers and 544

units of capitals, &hile cloth production uses 54 &orkers

and 54 units of capitals, then food production is capital-

intensive and cloth production is labor-intensive!



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CC

FF

Wage-rental

ratio, w/r

Capital-labor

ratio, K/L


actor rices and Input 6hoices


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actor rices and 7oods rices

• Stolper-Samuelson Theorem (effect): ( If the relative price of a 'ood increases, holdin' factor

supplies constant, then the no#inal and real return )inter#s of both 'oods* to the factor used intensively in the

production of that 'ood increases, &hile the no#inal

and real return )in ter#s of both 'oods* to the other

factor decreases! ( The reverse is also true!



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SS

Relative price of

cloth, P C /P

F

Wage-rental

ratio, w/r


actor rices and 7oods rices


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FF

CC

SS

Capital-

labor

Ratio, K/L

Relative

price of

cloth, P C /P

F

Wage-rental

ratio, w/r

(P C /P

F )1 (K

C /L

C )2(K C /LC )

1 (K F /L

F )2(K F /LF )

1

(w/r )2

(w/r )1

Increasing Increasing


ro# 7oods rices to Input 6hoices

(P C /P

F )2


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+n increase in the price of cloth relative to that of food, P C 1 P F ,&ill:

• Raise the inco#e of &orkers relative to that of capital-o&ners, w1r !

• Raise the ratio of capital to labor, K 1 L, in both cloth andfood production and thus raise the marginal product oflabor in ter#s of both 'oods!

• +s M8 9 .1, Raise the purchasin' po&er of &orkers

and lo&er the purchasin' po&er of capital-o&ners, byraisin' real &a'es and lo&erin' real rents in ter#s of both'oods!



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Resources and Output

• Ho& is the allocation of resources deter#ined/ ( 7iven the relative price of cloth and the supplies of

capital and labor, it is possible to deter#ine ho& #uchof each resource the econo#y devotes to the production

of each 'ood!



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LF

K F

LC

K C

Labor used in food production

Labor used in cloth production

O F

Increasing

Increasing

I n c

r e

a s

i n

g I n

c r

e a s

i n g

C a p i t a l u s e d

i n

c l o t h

p r o d u

c t i o n

Capital u

sed

i n

food

produc

tion

1

F

C

O C


The +llocation of Resources


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Ho& do the outputs of the t&o 'oods chan'e &hen

the econo#ys resources chan'e/

• ybc!ynski Theorem (effect):

( If a factor of production ) K or L* increases, then thesupply of the 'ood that uses this factor intensively

increases and the supply of the other 'ood decreases for

any 'iven co##odity prices!

( The reverse is also true!



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PP 1 PP 2

utput of

food, Q F

utput of

cloth, Q C

!lope " -P C /P

F

!lope " -P C /P

F

2Q 2

F

Q 2C

1Q 1

F

Q 1C


Resources and roduction ossibilities


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+n increase in the supply of capital )labor* leads to abiased e"pansion of production possibilities to&ardfood )cloth* production!

+n econo#y &ill tend to be relatively effective at producin' 'oods that are intensive in the factors &ith&hich the country is relatively &ell-endo&ed!



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+ssu#ptions of the Heckscher-Ohlin #odel:

• There are t&o countries )Ho#e and orei'n* that have: ( %a#e tastes

( %a#e technolo'y ( ifferent resources

( Ho#e has a hi'her ratio of labor to capital than orei'n

does

• "ach country has the sa#e production structure of at&o-factor econo#y!

"ffects of International Trade

;et&een T&o-actor "cono#ies


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Relative rices and the attern of Trade

• Factor #bundance ( Ho#e country is labor-abundant co#pared to orei'n

country )and orei'n is capital-abundant co#pared toHo#e* if and only if the ratio of the total a#ount oflabor to the total a#ount of capital available in Ho#e is'reater than that in orei'n:

L1 K 2 L


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• .hen Ho#e and orei'n trade &ith each other, theirrelative prices conver'e! The relative price of cloth

rises in Ho#e and declines in orei'n!

( In Ho#e, the rise in the relative price of cloth leads to arise in the production of cloth and a decline in relative

consu#ption, so Ho#e beco#es an exporter of cloth

and an i#porter of food!

( 6onversely, the decline in the relative price of cloth in

orei'n leads it to beco#e an i#porter of cloth and an

exporter of food!




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RD

RS

RS #

1

2

$



Trade 8eads to a 6onver'ence of Relative ricesRelative price

of cloth, P C /P

F

Relative %ualit&

of cloth, Q C


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Heckscher-Ohlin Theorem:

• + country &ill export that co##odity &hich usesintensively its abundant factor and i#port that

co##odity &hich uses intensively its scarce factor!



ff f i l d


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Trade and the istribution of Inco#e

• Trade produces a conver'ence of relative prices!• 6han'es in relative prices have stron' effects on the

relative earnin's of labor and capital in both countries:

( In Ho#e, &here the relative price of cloth rises:

( 8aborers are #ade better off and capital-o&ners are #ade &orseoff!

( In orei'n, &here the relative price of cloth falls, the

opposite happens: ( 8aborers are #ade &orse off and capital-o&ners are #ade betteroff!

• O&ners of a countrys abundant factors 'ain fro# trade, but o&ners of a countrys scarce factors lose!



ff f i l d


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ifference bet&een the specific factors #odel and theHeckscher-Ohlin #odel in ter#s of inco#edistribution effects:

• The specificity of factors to particular industries isoften only a temporary problem! ( "xa#ple: 7ar#ent #akers cannot beco#e co#puter

#anufactures overni'ht, but 'iven ti#e the Indianecono#y can shift its #anufacturin' e#ploy#ent fro#

declinin' sectors to expandin' ones!• In contrast, effects of trade on the distribution of

inco#e a#on' land, labor, and capital are #ore or less permanent !



"ff f I i l T d


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actor rice "0uali$ation

• In the absence of trade: labor &ould earn less in Ho#ethan in orei'n, and capital &ould earn #ore!

• Factor-$rice %&uali!ation Theorem: ( International trade leads to co#plete e0uali$ation in therelative and absolute returns to ho#o'eneous factors

across countries!

( It i#plies that international trade is a substitute for theinternational #obility of factors!



"ff f I i l T d


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• Has international trade e0uali$ed the returns toho#o'eneous factors in different countries in the real

&orld/

( "ven casual observation clearly indicates that it hasnot !

( "xa#ple: .a'es are #uch hi'her for doctors, en'ineers,

technicians, #echanics and laborers in the =nited %tates and

7er#any than in >orea and Mexico!

( =nder these circu#stances, it is #ore realistic to saythat international trade has reduced , rather than

co#pletely eli#inated, the international difference in

the returns to ho#o'eneous factors!



"ff f I i l T d


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• Three assu#ptions crucial to the prediction of factor price e0uali$ation are in reality untrue:

( ;oth countries produce both 'oods

( ;oth countries have the sa#e technolo'ies in production

( ;oth countries have the sa#e prices of 'oods due to

trade

• One thin' the factor-price e0uali$ation theore# doesnot say is that international trade &ill eli#inate or

reduce international differences in per capita incomes!




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Relative actor "ndoents

+ country &ill have a co#parative advanta'e in

producin' products that intensively use

resources )factors of production* it has inabundance

• 6hina: labor

• %audi +rabia: oil

• +r'entina: &heat

" i i l " id th


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Testin' the Heckscher-Ohlin Model

• Tests on 'S ata ( *eontief parado"

( 8eontief found that =!%! exports &ere less capital-intensive than=!%! i#ports, even thou'h the =!%! is the #ost capital-abundant

country in the &orld!

• Tests on +lobal ata

( + study by ;o&en, 8ea#er, and %veikauskas tested theHeckscher-Ohlin #odel usin' data for a lar'e nu#ber of

countries!

( This study confir#s the 8eontief paradox on a broader level!

"#pirical "vidence on the

Heckscher-Ohlin Model

i i l id h k h


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Indias Trade attern

"#pirical "vidence on the Heckscher-

Ohlin Model

;hard&a? )@AB5* studied IndiaCs trade pattern!

•IndiaCs exports &ere labor-intensive! 6onsistent &ith HO theory!

•Ho&ever, Indian trade &ith the =% &as not! Indian exports to the =% &ere capital-intensive!

Malhotra )54@@* analysed the India--6hina trade as a case study for H-O theore#!

•6hinaCs co#position of exports to India and i#ports fro# India sho&s that ,hina is a labor

abundant country relatie to India! This supports H-O Theorem 'iven that 6hina and IndiaCs

trade reflect their respective factor abundance &ith respect to their i#ports and exports!


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" i i l " id h H k h


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I#plications of the Tests

• "#pirical evidence on the Heckscher-Ohlin #odel hasled to the follo&in' conclusions:

( It has been less successful at explainin' the actual pattern of international trade!

( It has been useful as a &ay to analy$e the effects of

trade on inco#e distribution!

"#pirical "vidence on the Heckscher-

Ohlin Model

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IT- 04- HO model international Trade