Chapter 4

The Heckscher-Ohlin

Model

1

H-O Model

2

Empirical Evidence

3

Conclusions

Introduction

•

The Heckscher-Ohlin model (HO) shows how

trade occurs because countries that have different

resources.

•

They wanted to explain this increase in trade

during the “golden age” of international trade.

Introduction

•

The specific factors model in the last chapter was

a short run model since capital and labor could

not move between industries.

•

The HO model is a long run model because all

factors of production can move between the

industries.

•

Generalizations

 Many factors and goods

Heckscher-Ohlin Model

•

Two countries: Home and Foreign.

•

Two goods: computers and shoes.

•

Two factors of prod’n: labor (L) and capital (K).

•

Resource constraint equations:

 Capital in each good for each country

 K = K_C + K_S and K* = K*_C + K*_S

 Labor in each good for each country

Assumptions of the Heckscher-Ohlin Model

1.

Both factors can move freely between industries.

2.

Shoe production is labor-intensive; it requires

more labor per unit of capital to produce shoes

than computers, so that L

/K

> L

/K

.

 This means that computer production is capital-intensive.

Assumptions of the Heckscher-Ohlin Model

Assumptions of the Heckscher-Ohlin Model

3.

Foreign is labor abundant. Equivalently, Home is

capital abundant

 L*/K* > L/K and K/L > K*/L*

 Here, we do not consider why the amount of

resources differs across countries. Take as given.

4.

The final outputs, shoes and computers, can be

traded freely, without restrictions, between

nations, but labor and capital do not move

between countries.

Assumptions of the Heckscher-Ohlin Model

5.

The technologies used to produce the two goods

are identical across the countries.

 This is opposite of the assumption in the Ricardian model.

6.

Consumer tastes are the same across countries,

and preferences for computers and shoes do not

vary with a country's level of income.

APPLICATION

Are Factor Intensities the Same Across Countries?

•

As part of our assumptions, we assume that factor

intensities in each industry are the same in both

countries.

 E.g. shoes are labor intensive in both countries

•

Although all countries may have access to the

same technologies, the machines used in the U.S.

are different from those used in Asia and

elsewhere.

•

While the U.S. still produces some shoes, the

APPLICATION

Are Factor Intensities the Same Across Countries?

• Asian production uses old technology and workers earn

relatively little compared to the U.S.

 Labor intensive in Asia.

• In call centers, technologies and therefore factor intensities are similar across countries.

• So, shoes in India are labor intensive compared to the call

center—the opposite of the U.S.

• This illustrates Reversal of Factor Intensities between the

two countries.

Heckscher-Ohlin Model

No Trade Equilibrium

• As always, start with the no-trade equilibrium.

• Factor abundance and intensity (combined with total endowments) determine the shape of the PPFs:

 Home is capital abundant and computer production is capital intensive.

 Home is capable of producing more computers than shoes.  Foreign is abundant and shoe production is

labor-intensive.

 _{Foreign is capable of producing more shoes.}

• Indifference Curves

 Consumer tastes are the same across countries, so the

Heckscher-Ohlin Model

No Trade Equilibrium

Heckscher-Ohlin Model

•

No Trade Equilibrium Price

 The no-trade prices reflect the differing amounts of resources found in the two countries.

 Foreign has abundant labor.

 _{Shoe production is labor intensive.}

 _{The no-trade relative price of shoes is lower in Foreign.}

 People in Foreign are willing to give up more shoes for one computer since they have a lot of shoes.

 The same logic applies to Home.

 _{Home has abundant capital.}

 Computer production is capital intensive.

Heckscher-Ohlin Model

Free Trade Equilibrium

•

Three steps to finding free trade equilibrium

 Trace out the Foreign import demand for computers.

 Put together the export supply and the import demand to determine equilibrium relative price of computers.

•

Home Equilibrium with Free Trade (Figure 4.3)

 The Home PPF will show a free trade or world relative price of computers that is higher than the no-trade

Home relative price.

 They will produce more computers and fewer shoes.

Heckscher-Ohlin Model

Heckscher-Ohlin Model

•

We can use the Home trade information to graph

the exports of computers against the relative

price.

 Trace out the quantity of exports at each relative price.

 This gives the Home export supply curve for computers.

 It is upward-sloping since at higher relative prices,

Heckscher-Ohlin Model

Heckscher-Ohlin Model

•

Foreign Equilibrium with Free Trade



The Foreign PPF will show a free trade or world

relative price of computers that is lower than

the no-trade Foreign relative price.

•

Foreign can now consume on any point along

the world price line through point B*.

•

We can now define the Foreign “trade triangle”

which is the triangle that connects points B*

Heckscher-Ohlin Model

•

Next, we run through

the same steps for

the Foreign country.

•

Foreign specializes

further in shoes and

produces fewer

computers.

•

B* is where Foreign

produces and C* is

where Foreign

consumes.

Heckscher-Ohlin Model

Figure 4.4

• We can use the Foreign trade information to

graph the import of

computers against the relative price.

Heckscher-Ohlin Model

• The equilibrium free trade price is determined by the

intersection of the Home export supply curve and the foreign import demand curve: Point D.

• At that relative price,

the quantity that Home wants to export equals the amount that Foreign wants to import.

• This is a free-trade

equilibrium since there is no reason for the relative price to change.

Heckscher-Ohlin Model

•

Pattern of Trade

 This is the Heckscher-Ohlin Theorem:

With two goods and two factors, each country will export the good that uses intensively the factor of production it has in abundance, and will import the other good.

•

When trade opens:

 The relative price of computers in Home rises from the no-trade price.

 This gives Home an incentive to produce more computers and export the difference.

Heckscher-Ohlin Model

•

Testing the HO Theorem: Leontief’s Paradox

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.

Heckscher-Ohlin Model

• Leontief used labor and capital used directly in the production of final good exports in each industry.

• Capital is high because we are measuring the whole capital stock—not the part actually used to produce exports.

• 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 calculate estimated amounts of labor and capital used in imports from abroad.

Heckscher-Ohlin 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.

Heckscher-Ohlin Model

•

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.

Heckscher-Ohlin Model

•

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.

Effects of Trade on Factor Prices

• How do the changes in pre-trade and post-trade 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.

• Effect of Trade on the Wage and Rental rate of Home

 _{Derive an economy-wide relative demand for labor.}

 Compare it to the economy-wide relative supply of labor, L/K.

Effects of Trade on Factor Prices

•

Economy-Wide Relative Demand for Labor

 We can divide total labor by total capital to get the relative supply equal to the relative demand.

•

The relative demand is a weighted average of the

labor-capital ratio to each industry.

Effects of Trade on Factor Prices

• The relative demand curve is an average of the labor demand curves for each industry.

• The relative demand curve therefore lies between these two curves.

• Where the curves intersect gives the wage to rental rate ratio: W/R.

Effects of Trade on Factor Prices

Figure 4.8

The increase in Pc/Ps

Effects of Trade on Factor Prices

• 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.





























K

K

K

L

K

K

K

L

K

L

Effects of Trade on Factor Prices

•

Determination of the Real Wage and Real Rental

Rate.

 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.

 Real rental rate: R/P_S and R/P_C

Effects of Trade on Factor Prices

•

Change in the Real Rental Rate

 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 = P_C*MPK_C and R = P_S*MPK_S

 Rearranging we get:

 MPK_C = R/P_C and MPK_S = R/P_S

Effects of Trade on Factor Prices

•

Change in the Real Wage

 Since the labor/capital ratio increases in both

industries, 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 = P_C*MPL_C and W = P_S*MPL_S

 Rearranging

 MPL_C = W/P_C and MPL_S = W/P_S

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:

Effects of Trade on Factor Prices

•

A Numerical Example

 Suppose we have the following data:

 Computers Sales Revenue = P_CQ_C = 100

Earnings of labor = WL_C = 50 Earnings of capital = RK_C = 50

 Shoes Sales Revenue = P_SQ_S = 100

Effects of Trade on Factor Prices

• 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, P_C, increases while the price of shoes, P_S, does not change.

 Computers: % increase in price = ΔP_C/P_C = 10%

 Shoes: % increase in price = ΔP_S/P_S = 0%

• Our goal is to see how the increase in the relative price of computers translates into long run changes in the

Effects of Trade on Factor Prices

•

The rental rate on capital

is calculated by taking

payments to capital and

dividing by the amount of

capital:

•

Apply the following

assumptions:

ΔP

> 0 and ΔP

= 0,

to the last equations:

C C C

C

S S S

S

P Q

W L

R

K

P Q

W L

R

K



 





 



0

C C C

C

S S

S

P Q

W L

R

K

Q

W L

Effects of Trade on Factor Prices

•

Rewrite the last

equation in

percentage

changes:

•

Plugging in data

from before:

C C C C

C C C

S

S

P

P Q

W L

R

W

R

P

R K

W

R K

W L

R

W

R

W

R K

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%

 The real wage, measured in terms of either good, has fallen, so labor is worse off.

•

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%

Effects of Trade on Factor Prices

•

General Equation for the Long-Run Change in Factor

Prices

 In summary, for an increase in P_C

 ΔW/W < 0 < ΔP_C/P_S < ΔR/R

 _{Real wage falls, real rental increases}

•

We see what is referred to as a ‘magnification effect’

magnified effects on the earnings of factors.

APPLICATION

Opinions Toward Free Trade

•

A survey was conducted in the U.S. by the

National Elections Studies (NES) in 1992 to see

how citizens viewed trade.

 Respondents could either answer that they favor

placing limits on imports, not supporting free trade, or they could oppose limits on imports, supporting free trade.

 How do these answers compare with characteristics of the respondents, such as their wages, skills, or the

APPLICATION

Opinions Toward Free Trade

• If labor earns some of the return to capital, then workers in exporting (importing) industries will support (oppose) free trade.

• In the short run, the industry of employment of workers will affect their attitudes toward free trade.

• In the long run HO model, the industry of employment should not matter.

APPLICATION

Opinions Toward Free Trade

• In the NES survey, the industry of employment was

somewhat important in explaining respondents’ attitudes toward free trade, but skill level was much more important.

 Workers in export-oriented industries are somewhat more likely to favor free trade.

 _{Those in import-competing industries favoring import restrictions.}

• A much more important determinant of the attitudes

toward free trade is the skill level of workers, measured by wages or years of education.

APPLICATION

Opinions Toward Free Trade

• Respondents were also asked if they owned a home.

• People who owned homes in communities where the local industries face a lot of import competition are much more likely to oppose free trade.

• People who owned homes in communities where the

industries benefit from export opportunities are more likely to support free trade.

• People are concerned about the asset value of their

homes, just like the owners of specific-factors in our model are concerned about the rental earned by the factor of

Extending the Heckscher-Ohlin Model

• We need to make the HO model more realistic by allowing for more than two goods, factors, and

countries.

• As the second modification, we will allow the

technologies used to produce each good to differ across countries.

• 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.

Extending the Heckscher-Ohlin Model

•

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?

•

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.

Extending the Heckscher-Ohlin Model

• These values are called the factor content of exports

and factor content of imports.

• By taking the difference between the factor content of exports and factor content of 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.

•

Measuring Factor Abundance

 How should we measure factor abundance when there are more than two factors and two countries?

 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.

Extending the Heckscher-Ohlin Model

Extending the Heckscher-Ohlin Model

• Capital Abundance

 _{For example, 24% of the world’s physical capital is located in the} U.S., which had 21.6% of world GDP.

 _{We can conclude that the U.S. was abundant in physical capital in} 2000.

• Labor and Land Abundance

 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.

Extending the Heckscher-Ohlin 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.

Extending the Heckscher-Ohlin Model

•

Differing Productivities Across Countries

 Remember that Leontief found that the U.S. was

exporting labor-intensive products even though it was capital-abundant 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

Extending the Heckscher-Ohlin Model

•

Measuring Factor Abundance Once Again

 Effective Factor Endowment is the actual factor

endowment times the factor productivity.

 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.

Extending the Heckscher-Ohlin Model

• Effective R&D Scientists

 _{On way to measure this is through a country’s R&D spending per} scientist.

 Take the total number of scientists and multiply that by the R&D spending per scientists

 With these productivity corrections, the U.S. is more abundant in effective R&D scientists and China is lower.

• Effective 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.

Extending the Heckscher-Ohlin Model

HEADLINES

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.

Extending the Heckscher-Ohlin 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.

 A new version called the “sign test” is available.

 If a country is abundant in an effective factor, then the factor’s content in net exports should be positive.

Extending the Heckscher-Ohlin Theorem

• The sign test 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).

 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 Heckscher-Ohlin Theorem

• But labor’s factor content of net exports was positive.

• 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.

• The effective amount of labor found in each country equals the actual amount of labor times the wage.

Extending the Heckscher-Ohlin Model

Extending the Heckscher-Ohlin 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

APPLICATION

Why does India Import Cotton Textiles?

• From the 17th century until the early 19th century, India was

a major world producer of cotton textiles and exported those goods to Britain and elsewhere.

• By the early 19th century, however, Britain had overtaken

India as the world’s dominant producer of cotton textiles and was exporting to India.

• India still produced raw cotton needed to manufacture cotton cloth—the raw cotton was exported to Britain.

APPLICATION

Why does India Import Cotton Textiles?

• These countries are all labor abundant rather than land abundant, therefore it is puzzling why they seem to be net exporters of land and net importers of labor.

• Two explanations

1. Britain’s rise as the world’s leading exporter of cotton textiles was related to technological improvements.

APPLICATION

Why does India Import Cotton Textiles?

2.

The poor countries used this new technology

to make textiles inefficiently.

 Large differences in efficient use of technology across countries remained. .

• This inefficiency applied more strongly to labor than it did to other factors such as land.

• Estimates from 1910 and 1990 show that labor was not necessarily the abundant factor in India once we take into account its low productivity.

• India could be considered land-abundant if land and labor are measured by their “effective” amounts.