Download factor endowment

E&D
International Economics, 2
Lecture 11
Giorgia Giovannetti
E-mail: [email protected]
13-set
14-set
20-set
21-set
27-set
28-set
04-ott
06-ott
11-ott
13-ott
18-ott
20-ott
25-ott
27-ott
03-nov
Introduction:globalization and separation
No class
Measuring globalization, 1
Measuring Globalization, 2, Indicators
Overview trade models (Bernard et al 2007; 2011)
Exercises on indicators, data etc
China (invited Lecture)
The concept of Comparative advantage: the model of Ricardo
Ricardo and comparative advantage, 2
Ricardo, end
Trade models: H-O
H-O, 2
NO CLASS TO BE RECUPERATED
Exercises on Ricardo, H-O
Welcome piazza san marco
08-nov
Trade and imperfect competition
Geography models/gravity
10-nov
Introduction to the Melitz model
15-nov
The Melitz model, wrapping up; Hysteresis, Heterogeneous
firms
17-nov
Exercises on imperfect competition & Melitz model, recap
22-nov
Trade policy
24-nov
Trade Policy: TTIP
29-nov
FDI and Multinationals: OLI theory
2 people, 2 papers (30 minutes) Crespi, Fleming FDI;
01-dic
FDI and Multinationals Offshoring/trade in tasks
3 people, 2 – 3 papers (40 minutes): Bartoli, Rihko, Ronco: GVC
06-dic
Brexit discussion
3 people, 2-3 papers (45 minutes) Giannitrapani, Merlika,
Avdolli: Brexit then open discussion
NO CLASS- TO BE RECUPERATE
2 person, 1 paper (15-20 minutes): Senkebayeva: EU export
superstar; 1 paper (15- 20 minutes) Romualdi: EU
competitiveness
4 people, 2 articles,( 1,15 hour) Franchino, Perra, Vivoli, Vannelli:
Melitz
3 people, 2 -3 papers, (45 minutes) Ding, Khachaturian, Zhao:
Offshoring
2 people, 2 papers (30 minutes) Conte, Roshkian: migration,
factor mobility,
1 person, 1 paper (20 minutes) Acosta: TTIP; 2 people, 2 papers
Persiani, Junde: (30 minutes): China India
4 people, 3 articles, (40 minutes) Bonden, Quaghebeure,
denOulenReynaert: trade and wages
Summary last lecture
• We introduced the H-O model
• H-O theory emerged in Sweden.
• Eli Heckscher (an economic historian) developed the
core idea in a brief article in 1919.
• A clear overall explanation was developed and
publicized in the 1930s by Heckscher’s student Bertil
Ohlin (a professor and politician, a Nobel laureate).
• Ohlin’s arguments were later reinforced by Paul
Samuelson (another Nobel laureate), who derived
mathematical conditions under which the H-O
prediction was strictly correct.
3
H-O
The H-O theory emphasizes the role of relative
differences in resource endowments as the
ultimate determinant of comparative
advantage. The H-O theory explains
comparative advantage in terms of underlying
1. differences across countries in the availability
of factor resources (factor endowment) –
abundant vs scarce factors;
2. differences across products in the use of these
factors in producing the products – laborintensive, capital-intensive, land-intensive, etc.
4
Factor abundance
• different factor endowments refers to
different relative factor endowments, not
different absolute endowments.
• In other words, different factor
endowments = different factor
proportions.
5
Relative factor abundance
May be defined in two ways:
• physical definition (in terms of the physical
units of two factors). For example, (K/L)I >
(K/L)II  Country I is capital-abundant;
• price definition (in terms of the relative
prices. The greater the relative abundance
of a factor, the lower its relative price). For
example, (r/w)I < (r/w)II  Country I is
capital-abundant.
6
Commodity factor intensity
• A commodity is said to be factor-X-intensive
whenever the ratio of factor X to a second factor Y
is larger when compared with a similar ratio of
factor usage of a second commodity.
Consider labor:
• A country is relatively labor-abundant if it has a
higher ratio of labor to other factors than does the
rest of the world.
• A product is relatively labor-intensive if labor costs
are a greater share of its value than they are of
the value of other products.
7
How does the relative abundance of a
resource determine comparative advantage?
• When a resource is relatively abundant, its
relative cost is less than in countries where
it is relatively scarce.
• Difference in relative resource costs causes
the pre-trade differences in relative product
prices between two countries.
8
H-O in their words…
• The H-O theory says, in Ohlin’s own words:
Commodities requiring for their production much
of [abundant factors of production] and little of
[scarce factors] are exported in exchange for
goods that call for factors in the opposite
proportions. Thus indirectly, factors in abundant
supply are exported and factors in scanty supply
are imported.
(Ohlin, Bertil. International and Interregional
Trade, MA: Harvard University Press, 1933)
9
H-O Summary
• 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
10
H-O Model
– Two goods (different intensities), two factors;
– Both factors can move freely between the industries.
– Shoe production is labor-intensive—it requires more labor per
unit of capital to produce shoes than computers.
– Foreign is labor abundant; the labor-capital ratio in Foreign
exceeds that in Home. Equivalently, Home is capital abundant.
– The final outputs can be traded freely between nations, but
labor and capital do not move between countries.
– The technologies used to produce the two goods are identical
across the countries.
– Consumer tastes are the same across countries, and
preferences for computers and shoes do not vary with a
country’s level of income.
First we determined equilibrium in
autharky
The Textbook 2×2 H-O Model,
summary
•
•
•
•
•
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”)
13
Summary Heckscher-Ohlin Model
No-Trade Equilibrium
Production Possibilities Frontiers, Indifference Curves, and No-Trade
Equilibrium Price
FIGURE 4-2 (1 of 3)
No-Trade Equilibria in Home and Foreign
The Home production possibilities
frontier (PPF) is shown in panel (a),
and the Foreign PPF is shown in panel
(b).
Because Home is capital
abundant and computers are
capital intensive, the Home PPF
is skewed toward computers.
Summary Heckscher-Ohlin Model
No-Trade Equilibrium
Production Possibilities Frontiers, Indifference Curves, and No-Trade
Equilibrium Price
FIGURE 4-2 (2 of 3)
No-Trade Equilibria in Home and Foreign (continued)
Home preferences are summarized by
the indifference curve, U.
The Home no-trade (or autarky)
equilibrium is at point A.
The flat slope indicates a low
relative price of computers, (PC /PS)A.
Summary Heckscher-Ohlin Model
No-Trade Equilibrium
Production Possibilities Frontiers, Indifference Curves, and No-Trade
Equilibrium Price
FIGURE 4-2 (3 of 3)
No-Trade Equilibria in Home and Foreign (continued)
Foreign preferences are summarized by the
Foreign is labor-abundant and shoes are
labor- intensive, so the Foreign PPF is skewed indifference curve, U*
The Foreign no-trade equilibrium is at point
toward shoes.
A*, with a higher relative price of
computers, as indicated by the steeper
slope of (P*C /P*S)A*.
Then we opened up to trade ….
Summary: Heckscher-Ohlin Model
Free-Trade Equilibrium
Home Equilibrium with Free Trade
FIGURE 4-3 (1 of 2)
International Free-Trade Equilibrium at Home
At the free-trade world relative price of computers,
(PC /PS)W,
Home produces at point B in panel (a) and consumes
at point C,
exporting computers and importing shoes.
Point A is the no-trade equilibrium.
The “trade triangle” has a base equal to the
Home exports of computers (the difference
between the amount produced and the
amount consumed with trade, (QC2 − QC3).
Summary: Heckscher-Ohlin Model
Free-Trade Equilibrium
Home Equilibrium with Free Trade
FIGURE 4-3 (2 of 2)
International Free-Trade Equilibrium at Home (continued)
The height of this triangle is the Home imports
of shoes (the difference between the amount
consumed of shoes and the amount produced
with trade, QS3 − QS2).
In panel (b), we show Home exports
of computers equal to zero at the notrade relative price, (PC /PS)A,
and equal to (QC2 − QC3) at the freetrade relative price, (PC/PS)W.
Summary Heckscher-Ohlin Model
Free-Trade Equilibrium
Foreign Equilibrium with Free Trade
FIGURE 4-4 (1 of 2)
International Free-Trade Equilibrium in Foreign
At the free-trade world relative price of computers,
(PC /PS)W,
Foreign produces at point B* in panel (a) and
consumes at point C*,
importing computers and exporting shoes.
Point A* is the no-trade equilibrium.)
The “trade triangle” has a base equal to
Foreign imports of computers (the difference
between the consumption of computers and
the amount produced with trade, (Q*C3 −
Q*C2).
Summary Heckscher-Ohlin Model
Free-Trade Equilibrium
Foreign Equilibrium with Free Trade
FIGURE 4-4 (2 of 2)
International Free-Trade Equilibrium in Foreign (continued)
The height of this triangle is Foreign exports
of shoes (the difference between the
production of shoes and the amount
consumed with trade, Q*S2 – Q*S3).
In panel (b), we show Foreign imports of
computers equal to zero at the no-trade
relative price, (P*C /P*S)A*, and equal to
(Q*C3 − Q*C2) at the free-trade relative
price, (PC /PS)W.
Summary: Heckscher-Ohlin Model
Free-Trade Equilibrium
Equilibrium Price with Free Trade Because exports equal imports, there is no
reason for the relative price to change and so this is a free-trade equilibrium.
FIGURE 4-5 Determination of the Free-Trade World Equilibrium Price
The world relative price of
computers in the free-trade
equilibrium is determined at the
intersection of the Home export
supply and Foreign import
demand, at point D.
At this relative price, the quantity
of computers that Home wants to
export, (QC2 − QC3), just equals the
quantity of computers that Foreign
wants to import, (Q*C3 − Q*C2).
Summary: Heckscher-Ohlin Model
Free-Trade Equilibrium
Pattern of Trade
• Home exports computers, the good that uses
intensively the factor of production (capital) found in
abundance at Home.
• Foreign exports shoes, the good that uses intensively
the factor of production (labor) found in abundance
there.
• This important result is called the Heckscher-Ohlin
theorem.
More in detail: Heckscher-Ohlin
• Since the two nations have equal tastes, they face
the same indifference map.
 Indifference curve I is the highest IC that Nation
1 and Nation 2 can reach in isolation, and points
A and A/ represent their equil. points of
production and consumption in the absence of
trade.
 The tangency of IC I at points A and A/ defines
the no-trade equil-relative commodity prices of PA
in Nation 1 and PA/ in Nation 2.
 Since PA < PA/ , Nation 1 has a com-adv. in X and
Nation 2 has a com-adv. in Y.
The Heckscher-Ohlin Model.
 The right panel shows that with trade Nation 1
specializes in X and Nation 2 in Y.
 Specialization continues until Nation 1 reaches
point B and Nation 2 B/, where the transformation
curves are tangent to the common relative price
line PB.
 Nation 1 exports X in exchange for Y and
consume at point E on IC II. Nation 2 exports Y
for X and consume at point E/ (which coincides
with point E).
 Note that Nation 1’s exports of X equal Nation 2’s
imports of X (i.e. BC=C / E /).
 Similarly, Nation 2’s exports of Y equal Nation
1’s imports of Y (i.e. B / C / =C E).
 At PX/PY > PB, Nation 1 want to export more of X
than Nation 2 wants to import at this high relative
price, and PX/PY falls towards PB.
 At PX/PY < PB, Nation 1 want to export less of X
than Nation 2 wants to import at this low relative
price, and PX/PY rises towards PB.
 Point E involves more of Y but less of X than
point A
 However, Nation 1 gains from trade because E is
on higher IC II.
 Similarly, at E/ which involves more X but less Y
than A/, Nation 2 is better of because E/ is on
higher IC II.
Heckscher-Ohlin Model
• When a country opens to trade:
– The relative price of computers in Home rises from the notrade price.
• This gives Home an incentive to produce more computers
and export the difference.
– The relative price of computers in Foreign falls from the notrade price.
• This gives Foreign an incentive to produce fewer computers
and import the difference.
• This also means the relative price of shoes in Foreign arises
giving Foreign the incentive to increase production and
export the difference
H-O Summary
• The Heckscher-Ohlin (H-O) Model Implications
– Countries export goods that use intensively their
abundant factors (H-O Theorem)
– Trade draws factor prices closer together across
countries, becoming equal in certain circumstances (FPE
Theorem)
– Trade changes real factor prices (S-S Theorem)
• Benefiting owners of abundant factors
• Hurting owners of scarce factors
– Rybczynski Thm (output effects of factor accumulation)
29
Strong … Assumptions
•
•
•
•
Perfect competition
Constant returns to scale
No factor mobility
Two countries must be identical and trade
must be balanced
Test of the Heckscher-Ohlin Model
The Test:
• W. Leontief (1951)
• Could “H-O … Factor Proportions Theory”
be used to explain the types of goods the
United States imported and exported?
The Method:
Built input-output model for 200 U.S.
industries for 1947
EMPIRICAL EVIDENCE ON THE H-O
FACTOR-PROPORTIONS THEORY
The Findings:
• The Leontief Paradox
– Leontief found that U.S. exports were less
capital-intensive than U.S. imports, even
though U.S. is the most capital-abundant
country in the world
The Leontief Paradox
The Controversy:
Findings were the opposite of what was
generally believed to be true!
Reconciliations of the Leontief
Paradox
• U.S. workers are more productive than foreign
workers (Leontief) and Human Skills Theory (1966)
• A third factor, natural resources, is not considered
(Vanek)
• U.S. tariffs on labor-intensive goods are high (Travis)
• The identical tastes assumption is violated; Table
(next page) shows that consumption patterns differ
across countries
Consumption Shares by Product Type for OECD Countries
Average Values 1985–1999*
Human Skills Theory
• Donald Keesing (1966)
• Emphasizes differences in endowments and
intensities of skilled and unskilled workers.
• Explains the Leontief paradox:
Since the U.S. has highly trained, educated
workers relative to other countries, U.S.
exports tend to be skilled-labor intensive.
Testing the H-O Theorem: Leontief’s Paradox
– Wassily Leontief performed the first test of the HO
theorem in 1953 using data for the U.S. from 1947.
– He measured the amounts of labor and capital used in all
industries needed to produce $1 million of U.S. imports
and to produce $1 million of imports into the U.S.
– This data also shows the capital/labor ratio in dollars per
person.
Heckscher-Ohlin Model
Leontief’s Test
H-O Model
• Leontief used labor and capital used directly in the production of final
good exports in each industry.
• He also measured the labor and capital used indirectly in the industries
that produced the intermediate inputs used in making exports.
• The capital is high because we are measuring the whole capital stock—not
the part actually used to produce exports.
• The capital/labor ratio was $14,000: each person employed was working
with $14,000 worth of capital.
• It was impossible for Leontief to get information on the amount of labor
and capital used to produce imports.
• He used data on U.S. technology to estimate amounts of labor and capital
used in imports from abroad. (Remember the HO model assume
technologies are the same across countries.)
• This gave a capital/labor ratio of $18,200 per worker.
– This exceeds the ratio for exports.
H-O Model
• Leontief assumed correctly that in 1947 the U.S. was capital
abundant relative to the rest of the world.
– From the HO model, Leontief expected that the U.S.
would export capital intensive goods and import labor
intensive goods.
• Leontief, however, found the opposite.
– The capital labor ratio for U.S. imports was higher than for
exports.
• This contradiction came to be called Leontief’s paradox.
The Leontief Paradox
• Why would this paradox exist?
• U.S. and foreign technologies are not the same as
assumed.
• By focusing only on labor and capital, land abundance in
the U.S. was ignored.
• No distinction between skilled and unskilled labor.
• The data for 1947 could be unusual due to the recent end
of WWII.
• The U.S. was not engaged in completely free trade as is
assumed by the HO model.
Leontief Paradox, 2
• Several of the explanations depend on having more than two
factors of production.
– The U.S. is land abundant, and much of what it was
exporting might have been agricultural products which use
land intensively.
– It might also be true that many of the exports used skilled
labor intensively.
• More current research was aimed at redoing the Leontief test.
– The “extended” HO model works much better for the same
year of data.
Summary Testing the Heckscher-Ohlin
Model
Differing Productivities across Countries
Measuring Factor Abundance Once Again To allow factors of
production to differ in their productivities across countries, we
define the effective factor endowment as the actual amount of
a factor found in a country times its productivity:
Effective factor endowment = Actual factor endowment • Factor
productivity
Criticism
• We may not see the clear-cut income
distribution effects with trade because relative
factor prices in the real world do not often
appear to be as responsive to trade as the H-O
and S-S imply.
• In addition, income distribution reflects not
only the distribution of income between
factors of production but also the ownership
of the factors of production. Since individuals
or households often own several factors of
production, the final impact of trade on
personal income distribution is far from clear.
44
Effects of Trade on Factor Prices
• How do the changes in pre-trade and posttrade relative prices affect the wage paid to
labor in each country and the rental earned by
capital?
– Remember the relative price of computers in
Home increase, causing them to export
computers.
– The relative price of computers in Foreign
decreases, causing them to import computers.
Effects of Trade on Factor Prices
• Effect of Trade on the Wage and Rental of
Home
– We can use the relative demand for labor in each
industry to derive an economy-wide relative
demand for labor.
– We can then compare it to the economy-wide
relative supply of labor, L/K.
– This will determine Home’s relative wage and
what happens after the relative price of
computers changes.
Effects of Trade on Factor Prices
• Economy-Wide Relative Demand for Labor
– The quantities of labor and capital used in each
industry add up to the total available labor and
capital.
• K = KC + KS and L = LC + LS
• We can divide total labor by total capital to get the
relative supply equal to the relative demand.
L LC  LS LC  KC



K
K
KC  K
Relative Supply
 LS

 KS
Relative Demand
 KS 


K 
Effects of Trade on Factor Prices
• The relative demand is a weighted average of the labor-capital
ratio to each industry.
– This weighted average is obtained by multiplying the laborcapital ratio for each industry by KC/K and KS/K.
• These are the shares of total capital employed in each
industry.
• The equilibrium relative wage is determined by the
intersection of the relative supply (L/K) and the relative
demand curves.
– Remember the amounts of labor and capital do not
depend on the relative wage.
Effects of Trade on Factor Prices
• The relative demand is an average of the labor curves
for each industry.
• The relative demand curve therefore lies between
these two curves.
• Where the curves intersect gives the wage relative
to the rental: W/R.
Effects of Trade on Factor Prices
Point A describes an
equilibrium in the labor and
capital markets—it
combines these two markets
into a single diagram by
showing the relative supply
equal to the relative
demand.
Effects of Trade on Factor Prices
• Increases in the Relative Price of Computers
– PC/PS increases at Home.
– Production shifts away from shoes to computers.
• Shoe production decreases and computer production
increases.
– Labor and capital both move from shoe production to
computer production.
– Relative labor supply does not change.
– Since capital has shifted to the computer industry, the
relative demand for labor changes.
• The terms used in the weighted average, KC/K and KS/K,
change.
Effects of Trade on Factor Prices
• Increases in the Relative Price of Computers
– The relative demand for labor is now more
weighted toward computers.
– The relative demand for labor is now less
weighted toward shoes.
Effects of Trade on Factor Prices
The real
wageinfalls
which
increase
the
relative
Initial
equilibrium
before
increases
the
amount
ofof
price of in
computers
causes
change
relative
price
workers
per demand
unit of capital
the relative
curve in
to
computers
both
industries computers
shift left—toward
Effects of Trade on Factor Prices
• From this, the labor-capital ratio rises in both
shoes and computers.
• How does this happen?
– More labor per unit of capital is released from
shoes than is needed to operate that capital in
computers.
– As the relative price of computers rises, computer
output rises while shoe output falls.
– Labor is “freed up” to be used more in both
industries.
Effects of Trade on Factor Prices
• We can use our earlier equation for relative
supply and demand to show the response to
the increase in the relative price of computers,
PC/PS.
LC  K C
L


K KC  K
 LS  K S 



 KS  K 
Relative
Supply
No change
Relative Demand
No change in total
Effects of Trade on Factor Prices
• The relative supply has not changed, so the relative demand
cannot change overall.
• Individual components of the relative demand change, but
counteract each other to keep total relative demand the
same.
– More capital used in the computer industry so, KC/K rises
while KS/K falls.
• Output of computers rises and output of shoes falls.
– Labor/capital ratio in both industries increases.
– The relative demand continues to equal relative supply.
Effects of Trade on Factor Prices
• Determination of the Real Wage and Real
Rental.
– Who gains and who loses from the change in the
relative price of computers?
– We need to determine the change in the real
wage and real rental.
• The change in the quantity of shoes and computers
that each factor of production can purchase.
Effects of Trade on Factor Prices
• Change in the Real Rental
– Because the labor/capital ratio increases in both
industries, the marginal product of capital increases.
• There are more people to work with each unit of
capital.
– The rental rate of capital is determined by its marginal
product.
• R = PC*MPKC
• R = PS*MPKS
– Capital can move freely between industries in the long run.
• The rental rate will be equalized across industries.
Effects of Trade on Factor Prices
• Change in the Real Rental
– Both marginal products of capital increase.
– Rearranging the previous equation we get:
• MPKC = R/PC and MPKS = R/PS
– R/PC measures the quantity of computers that can be
purchased with the rental.
– R/PS measures the quantity of shoes that can be bought
with the rental.
– Since the MPKC and MPKS both increase, R/PS and R/PC must
increase as well.
Effects of Trade on Factor Prices
• Change in the Real Rental
– Therefore, capital owners are clearly better off
when the relative price of capital increases.
– Computers are the capital intensive industry and
the relative price of capital has increased.
An increase in the relative price of a good will
benefit the factor of production used intensively
in producing that good.
Effects of Trade on Factor Prices
• Change in the Real Wage
– Again we make use of the fact that the labor/capital ratio
increases in both industries.
– The law of diminishing returns tells us the marginal
product of labor must decrease in both industries.
– As before the wage is determined by the marginal product
of labor and the price of goods.
• W = PC*MPLC and W = PS*MPLS
– Rearranging
• MPLC = W/PC and MPLS = W/PS
Effects of Trade on Factor Prices
• Change in the Real Wage
– W/PC is the quantity of computers that can be
purchased with the wage.
– W/PS is the quantity of shoes that can be
purchased with the wage.
– MPLC and MPLS decrease, so W/PC and W/PS
decrease.
– Labor is clearly worse off due to the increase in
the price of computers.
Effects of Trade on Factor Prices
• The Stolper-Samuelson Theorem:
In the long run when all factors are mobile, an
increase in the relative price of a good will
increase the real earnings of the factor used
intensively in the production of that good and
decrease the real earnings of the other factor.
• Therefore, in the Heckscher-Ohlin model:
The abundant factor gains from trade, and the
scarce factor loses from trade.
Changes in the Real Wage and Rental:
A Numerical Example
– Suppose we have the following data:
– Computers Sales Revenue = PCQC = 100
Earnings of labor = WLC = 50
Earnings of capital = RKC = 50
– Shoes
Sales Revenue = PSQS = 100
Earnings of labor = WLS = 60
Earnings of capital = RKS = 40
Shoes are more labor-intensive than
computers
– The share of total revenue paid to labor in shoes
(60%) is more than the share in computers (50%).
• When trade opens, the relative price of
computers, PC, increases while the price of
shoes, PS, does not change.
– Computers: % increase in price = ΔPC/PC = 10%
– Shoes:
% increase in price = ΔPS/PS = 0%
Effects of Trade on Factor Prices
• Our goal is to see how the
increase in the relative price
of computers translates into
long run changes in the wage
and rental.
• Rental on capital is
calculated by taking total
sales revenue in each
industry, subtracting the
payments to labor, and
dividing by the amount of
capital:
PC  QC  W  LC
R
KC
PS  QS  W  LS
R
KS
Effects of Trade on Factor Prices
• Since the price of
computers has risen,
ΔPC > 0 and ΔPS = 0.
• Using this in the last
equations:
PC  QC  W  LC
R 
KC
0  QS  W  LS
R 
KS
Effects of Trade on Factor Prices
• We can rewrite the last equation in percentage
changes:
R  PC  PC  QC   W   W  LC 






R  PC  R  KC   W   R  K C 
R
W   W  LS 

 


R
 W   R  KS 
Effects of Trade on Factor Prices
• Plugging in data from before
R
 100   W  50 
 10%

 
R
 50   W  50 
R
 W  60 
 
 
R
 W  40 
• Our goal is to find out by how much rental
and wage change given changes in the
relative price of the final goods
 Solve for 2 unknowns with 2 equations
Effects of Trade on Factor Prices
• After solving we get:
– (ΔW/W) = -(20%/0.5) = -40%
– When the price of computers increases by 10%,
the wage falls by 40%
– Labor can no longer afford to buy as many
computers or shoes.
– The real wage, measured in terms of either good,
has fallen, so labor is worse off.
Effects of Trade on Factor Prices
• We can also see:
– (ΔR/R) = -(ΔW/W)(60/40) = 60%
– Rental on capital increases by 60% when the price
of computers rises by 10%
– Owners of capital can afford to buy more of both
computers and shoes.
– The real rental measured in terms of either good
has gone up, and capital owners are clearly better
off.
Effects of Trade on Factor Prices
• These equations relating the changes in
product prices to change in factor prices are
sometimes called the “magnification effect.”
– They show how changes in the prices of goods
have magnified effects on the earnings of factors.
– Even modest fluctuations in the relative prices of
goods on world markets can lead to exaggerated
changes in the long-run earnings of both factors.
• This shows why some are opposed to trade
and some support it.
H-O model, Effects of Trade on Factor Prices:
Summary
In the long run we can summarize as follows:
– For an increase in PC
• ΔW/W < 0 < ΔPC/PC < ΔR/R
• Real wage falls, real rental increases
– For a decrease in PC
• ΔR/R < ΔPC/PC < 0 < ΔW/W
• Real rental rate falls, real wage increases
– For an increase in PS
• ΔR/R < 0 < ΔPC/PC < ΔW/W
• Real rental falls, real wage increases
FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME
• Moving from autarky to free trade
– What happens to the relative size of
industries?
– What happens to the payments or returns
to factors of production?
– What happens to the distribution of income
within the country?
FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME
• Factor-Price Equalization
– When trade occurs between countries with
different factor proportions, free trade will
equalize the relative price of the goods (we
saw this in H-O)
– … and cause the relative factor prices to
converge
– Convergence of factor prices happens in the
long run
FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME
• Factor-Price Equalization
– Whichever factor receives the lowest price
before two countries begin to trade will
therefore tend to become more expensive
relative to other factors in the economy, …
while those with the highest price will tend
to become cheaper.
FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME
• For example – U.S. and India
– Trade opening up causes prices of machines
and the prices of cloth to equalize between
countries (H-O)
– Size of machine and cloth industries will
change for each country changing their
industrial structure
FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME
• (Assume) U.S. has a comparative advantage
in machines … (machines are K intensive)
– This causes an increased demand for machines
– The price of machines rises relative to price of
cloth
– Machine production expands
– Cloth production contracts
– Increased demand for inputs to make machines
FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME … (continued)
– Increase in capital greater than increase in labor
as machines are capital intensive
– Resources shift from cloth to machines
– Cloth industry declines
•
•
•
•
Imports replace much domestic production
More labor than capital released on market
Shortage of capital increase “profit” (return to K)
Surplus of labor decreases wages
• Ratio of wages to “profit” (return to K) declines
FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME
• India has a comparative advantage in cloth
– Increased demand for cloth
– Price of cloth rises relative to price of
machines
– Machine production contracts
– Cloth production expands
– Increased demand for inputs to make cloth
FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME
• Increase in labor greater than increase in capital
as cloth is labor intensive
• Resources shift from machines to cloth
• Machine industry declines
–
–
–
–
Imports replace much domestic production
More capital than labor released on market
Shortage of labor increase wages
Surplus of capital decreases “profit”
• Ratio of wages to “profit” increases
FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME
• Wages
– Decline in U.S.
– Increase in India
• “Profits” (return to capital)
– Increase in U.S.
– Decrease in India
Overall – Factor Prices get closer to equalization
(just as we saw with “Goods Prices” in H-O
FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME
• Trade and the Distribution of Income
– Trade produces a convergence of relative prices
– Changes in relative prices have strong effects on the
relative earnings of labor and capital in both countries
• In U.S., where the relative price of machines rises
• Capitalists are made better off and workers are made worse
off
• In India, where the relative price of machines falls, the
opposite happens
• Capitalists are made worse off and workers are made better
off
– Owners of a country’s abundant factors gain from
trade, but owners of a country’s scarce factors lose
FACTOR-PRICE EQUALIZATION AND THE
DISTRIBUTION OF INCOME
Table 4.4
Economic Data for South Korea and India
Economic Variable
GDP per Capita
Capital/Worker
Degree of Openness
[(Exports + Imports)/GDP]
South Korea
India
Year
Value
Year
Value
1953
$796
1953
$641
1962
$928
1962
$760
1972
$1,450
1972
$786
1982
$3,395
1982
$936
1991
$7,251
1991
$1,251
1965
$2,093
1965
$786
1975
$6,533
1975
$1,259
1085
$12,036
1085
$1,712
1992
$17,995
1992
$1,997
1953
11.8%
1953
10.4%
1962
22.1%
1962
11.2%
1972
44.5%
1972
8.8%
1982
71.5%
1982
14.5%
1990
62.5%
1990
21.2%
More on the Stolper-Samuelson Theorem
• Derived from the HO model
• Assumptions:
– Labor earns wages proportionate to its skill level
– Owners of capital earn profits
– Landowners earn rents
– The amount of income earned per unit of input depends on
both the demand for inputs and the supply of inputs
(demand for an input = derived demand)
The Stolper-Samuelson Theorem
• An increase in the demand for a good (opening International
Trade?) … increases the price of a good…. and raises the
income earned by factors that are used intensively in its
production
• Conversely, decrease in the demand for a good …
decreases the price of a good…. and reduces the income
earned by factors that are used intensively in its production
The Stolper-Samuelson Theorem
Example … increase production of steel … increase need for K ...
The Stolper-Samuelson Theorem
• Note:
• Not all factors used in the export industries will be better off,
and not all factors used in import competing industries get
hurt: Abundant factors will benefit, while scarce ones will be
hurt
The Stolper-Samuelson Theorem
• Ultimately, the effects on income of an opening of
trade depends on the flexibility of the affected
factors
– If labor is stuck in bread production and unable to move to
making steel, it will be hurt much worse than when it is
flexible and free to move
– U.S. avocado producers might not oppose Mexican
avocado imports as fiercely as they do, if they could easily
move to producing other goods
Implications of Stolper-Samuelson
Theorem
• Some groups in society will oppose international
trade.
• Scarce factors will lobby government for trade
protection.
• Even though some in society lose, the country
overall benefits from international trade relative
to autarky.
• A system of taxation and transfers could be
developed to compensate the losers while leaving
the gainers better off relative to autarky.
Implications of
Stolper-Samuelson Theorem
• Some groups in society will oppose international
trade.
• Scarce factors will lobby government for
trade protection.
• Even though some in society lose, the country
overall benefits from international trade relative
to autarky.
• A system of taxation and transfers could
be developed to compensate the losers
while leaving the gainers better off relative
to autarky.
4-91
Extending the Heckscher-Ohlin Model
• The HO model can be made more realistic by
allowing for more than two goods, factors,
and countries.
– This is the first modification to the model.
• As the second modification, we will allow the
technologies used to produce each good to
differ across countries.
Extending the H-O Model
• Many Goods, Factors, and Countries
– The predictions of the HO model depend on knowing
what factor a country has in abundance, and which good
uses that factor intensively.
– When there are more than two goods, it is more
complicated to evaluate factor intensity and factor
abundance.
• Measuring the Factor Content of Trade
– How do we measure the factor intensity of exports and
imports when there are thousands of products traded
between countries?
– How can we use this to test the HO model?
Extending the H-O Model
• Measuring the Factor Content of Trade
– Using Leontief’s test, we can look at similar data.
– We can multiply his numbers shown in Table 4.2 by the actual
value of U.S. exports and U.S. imports.
• This gives values for “total exports” and “total imports.”
– These values are called the factor content of exports and factor
content of imports.
• They measure the amounts of labor and capital used to
produce exports and imports.
– By taking the difference between the factor content of exports
and factor content of imports.
Extending the Heckscher-Ohlin Model
Factor Content of Trade for the United States, 1947
Seen yesterday
This table extends Leontief’s test of the Heckscher-Ohlin model to measure the
factor content of net exports. The first column for exports and for imports shows
the amount of capital or labor needed per $1 million worth of exports from or
imports into the United States, for 1947. The second column for each shows the
amount of capital or labor needed for the total exports from or imports into the
United States. The final column is the difference between the totals for exports
and imports.
Extending the Heckscher-Ohlin Model
• Measuring the Factor Content of Trade
– Since both these factor contents are positive, we
see that the U.S. was running a trade surplus.
– The U.S. exported large amounts of goods to help
countries of Europe rebuild after WWII.
– The fact that the factor content of net exports for
both capital and labor are positive will be
important as we move forward.
Extending the H-O Model
• Measuring Factor Abundance
– How should we measure factor abundance when there
are more than two factors and two countries?
– To determine whether a country is abundant in a
certain factor, we compare the country’s share of that
factor with its share of world GDP.
– If the share of a factor > share of world GDP.
• The country is abundant in that factor.
– If the share of factor < share of world GDP.
• The country is scarce in that factor.
Extending
the
H-O
Model
Country Factor Endowments, 2000
Extending the H-O Model
• Capital Abundance
– 24% of the world’s physical capital is located in the U.S., 8.7% is
located in China, 13.3% in Japan, etc.
– The final bar in the graph shows each country’s % of world GDP.
• The U.S. had 21.6% of world GDP, China had 11.2%, Japan had
7.5%, etc.
• We can conclude that the U.S. was abundant in physical capital in
2000.
– Japan and Germany were also abundant in physical capital.
– The opposite holds for China and India—their shares of world
capital are less than their share of GDP.
• They are scarce in capital.
Extending the H-O Model
• Labor and Land Abundance
– We can use a similar comparison to determine
whether each country is abundant or not in R&D
scientists, in types of labor distinguished by skill, in
arable land, or any other factor of production.
– For example:
• U.S. is abundant in R&D scientists: 26.1% of the world’s
total as compared to 21.6% of the world’s GDP.
• The U.S. is also abundant in skilled labor but is scarce in
less-skilled labor and illiterate labor.
• India is scarce in R&D scientists: 2.5% of world’s total as
compared to 5.5% of the world’s GDP.
Extending the H-O Model
• Labor and Land Abundance
– The U.S. is also scarce in arable land which is surprising
since we think of the U.S. as a major exporter of
agriculture.
– Another surprise is that China is abundant in R&D
scientists.
– These findings seem to contradict HO model.
– It is likely that the productivity of R&D scientists and arable
land are not the same in both countries.
– In this case, shares of GDP are not the whole story.
– We need to allow for differences in productivity.
Extending the H-O Model
• Differing Productivities Across Countries
– Remember that Leontief found that the U.S. was exporting
labor-intensive products even though it was capitalabundant at that time.
– One explanation is that labor is highly productive in the
U.S. and less productive in the rest of the world.
• Then the effective labor force in the U.S. is much larger
than if we just count people.
• Effective labor force is the labor force times its
productivity.
– We can now look at differing productivities into the HO
model.
Extending the H-O Model
• Measuring Factor Abundance Once Again
– Effective Factor Endowment is the actual factor endowment
times the factor productivity.
– The amount of effective labor in the world is found by adding
up the effective factor endowments across all countries.
– To determine if a country is abundant in a certain factor, we
compare the country’s share of that effective factor with
share of world GDP.
• If share of an effective factor is less than its share of world
GDP then that country is abundant in that effective factor.
• If share of an effective factor is less than its share of world
GDP, then that country is scarce in that effective factor.
Extending the H-O Model
• Effective R&D Scientists
– The effectiveness of an R&D Scientist depends on what
they have to work with.
– On way to measure this is through a country’s R&D
spending per scientist.
– If more spending, then scientist will be more productive.
– Take the total number of scientists and multiply that by the
R&D spending per scientists
– Figure 4.10 shows these shares.
– With these productivity corrections, the U.S. is more
abundant in effective R&D scientists and China is lower.
Extending the H-O Model
• Effective Arable Land
– We also need to do a correction for arable land.
– Effective arable land is the actual amount of arable land
times the productivity in agriculture.
– The U.S. has a very high productivity in agriculture
where China has a lower productivity.
– We repeat the same calculations from figure of 2000
• The 4th bar graph shows each country’s share of
effective arable land, corrected for productivity
differences
– The numbers before and after the correction are very
close.
• The U.S. is neither abundant nor scarce in effective
arable land.
Extending the Heckscher-Ohlin Model
“Effective” Factor Endowments, 2000
Food Imports Close to Matching
Level of Exports
• It is expected that by about 2010, U.S. imports
of agricultural goods will be about equal to
exports.
• That is what the HO model would predict,
given our finding that the U.S. is neither
abundant nor scarce in effective land.
Extending the H-O Theorem
• We have now abandoned many of the assumptions we
previously made.
– We allow for many goods, factors, and countries.
– We also allow for factors to differ in productivity.
– If a country is abundant in an effective factor, then the
factor’s content in net exports should be positive.
– If a country is scarce in an effective factor, then that
factor’s content in net exports should be negative.
Extending the H-O Theorem
• The est is as follows
– Sign of (country’s % share of effective factor minus the %
share of world GDP) equals Sign of (Country’s factor
content of net exports).
– For example, Table 4.2 shows that for capital the U.S. had a
positive factor content of net exports.
– Using 35 countries, the U.S. share of GDP of those
countries was 33%.
– Given the timing after WWII, we can assume that the U.S.
share of world capital was more than 33%.
– Therefore, the U.S. was abundant in capital and since that
factor’s content of net exports was positive, it passes the
sign test.
Extending the H-O Theorem
• The Test
– The U.S. share of population for the 35 countries was
about 8%.
– This is less than the U.S. share of GDP, 33%.
– Therefore, the U.S. was scarce in labor.
– But labor’s factor content of net exports was positive.
– The sign of U.S. factor abundance in labor is thus the
opposite of the sign of its factor content of net exports.
• The sign test seems to fail for the U.S. in 1947 in labor.
– However, the U.S. share of the population is not the right
way to measure the U.S. labor endowment.
One way to measure productivity is to use wages paid to workers.
Extending the H-O Model
A plot of wages of
workers in various
countries and the
estimated
productivity of
workers in 1990 is
shown in figure. You
can see these are
highly correlated.
The effective amount
of labor found in
each country equals
the actual amount of
labor times the
wage. The amount of
labor in each country
times the average
wages gives total
wages paid to labor.
Extending the H-O Theorem
• Doing this for 30 countries and comparing it to the U.S. we
find that the U.S. was abundant in effective labor.
• Given that the U.S. was abundant in effective factor, then
labor also passes the sign test, in addition to capital.
• There is no “paradox” in the U.S. pattern of trade.
• This explanation for Leontief’s paradox relies on taking into
account the productivity differences in labor across countries.
– As Leontief himself proposed, once we take into account differences in
the productivity of factors across countries, there is no “paradox” after
all.
Conclusions
• The HO model predicts real gains for the
factor used intensively in the export good,
whose relative price goes up with the opening
of trade, and real losses for the other factor.
• We have investigated some empirical tests of
the HO theorem.
• These tests originated with Leontief’s paradox,
the finding that U.S. exports just after WW II
were relatively labor intensive.
Conclusions
• With the test reformulated to use factor
amounts embodied in net exports and the
effective factor endowments in each country,
it was found that the U.S. was abundant in
effective labor and presumed it was in capital.
• The U.S. had positive factor content of L and K
in net exports, consistent with the sign test of
the extended HO model.
H-O, Summary
• The HO framework isolates the effect of different factor
endowments across countries and determines the
impact of these differences on trade patterns, relative
prices, and factor returns.
• By focusing on the factor intensities among goods, the
HO model provides guidance on who gains and who
loses from trade: the factor used intensively in the
export good, whose relative price goes up with the
opening of trade, gains, the other factor looses.
Empirics, Summary
• The original tests of H-O are due to Leontief, and
produced the Leontief’s paradox: the finding that U.S.
exports just after WW II were relatively labor intensive.
• With the test reformulated to use factor amounts
embodied in net exports and the effective factor
endowments in each country, it was found that the U.S.
was abundant in effective labor and presumed it was in
capital.
• The U.S. had positive factor content of L and K in net
exports, consistent with the sign test of the extended HO
model.
Free Trade Affects Income Distribution
4-117
Summary, Factor Price Equalization
Empirical evidence: no wage
equalization
Limits
Summary: International Trade and income
inequalities
Trade openess and inequality
Wages versus unemployment
inequalities
Explaining changes in income
inequalities
Compensating the losers
Changes in factor endowments:
Rybczynski Theorem
• At constant world prices, if a country
experiences an increase in the supply of one
factor, it will produce more of the product
intensive in that factor and less of the other.
The Rybcynski Theorem