Heckscher-Ohlin Model and Trade Notes

Introduction

• Ricardian Model: Trade arises from differences in relative labor productivity across countries.
• Heckscher-Ohlin Model: Trade results from differences in resources (factors of production) such as labor skills, physical capital, etc.

Heckscher-Ohlin Model Overview

• Nations differ in relative abundance of factors of production (endowments).
• Production processes use factors with varying relative intensity.

Implications of the H-O Model

1. Countries export goods that use relatively abundant factors and import goods that use scarce factors.
2. Owners of abundant factors gain from trade while owners of scarce factors lose.

Two-Factor Heckscher-Ohlin Model

• Two Countries: Home and Foreign
• Two Goods: Cloth and Food
• Two Factors of Production: Labor and Capital
• Factor Intensities: The mix of labor and capital used varies by goods.
• Fixed Endowments: Supply of labor and capital is constant across countries.
• In the long run, labor and capital can move across sectors to equalize wages and rental rates.

Trade and the Heckscher-Ohlin Model

• Assumptions for Trade:
  • Same consumer tastes and technology between countries.
  • Different relative factor endowments: Home has more labor; Foreign has more capital.
  • Key driver: $L/K > L/K$

Comparative Advantage

• Comparative advantage arises from differences in endowments.
• Example: Home (labor-rich) produces cloth (labor-intensive), while Foreign (capital-rich) produces food (capital-intensive).

Price Convergence and Trade Impacts

• Trade leads to convergence of relative prices of goods, enhancing supply of cloth in Home and food in Foreign.
• Home exports cloth and imports food; Foreign does the opposite.

Heckscher-Ohlin Theorem

• A country exports the good intensive in its abundantly available factor.
• Generalizes to multiple goods and factors leading to a clear export pattern.

Trade and Income Distribution

• Stolper-Samuelson Theorem: Rising prices of exported goods increase labor purchasing power and decrease capital purchasing power.
• Trade impacts income distribution, benefiting owners of abundant factors and hurting those of scarce factors.

U.S. Income Inequality

• The richest 1% earn substantially more than the bottom 20%, leading to increased income inequality.

North-South Trade and Technological Change

• Increased trade with developing countries correlates with U.S. income inequality.
• Wages for skilled workers rise faster than for unskilled workers in the context of new technologies.

Skill-Biased Technological Change

• Technological advancements favor skilled labor, furthering wage inequality.
• The impact of trade is complex and is intertwined with technological changes.

Factor Price Equalization

• H-O model predicts that free trade will equalize factor prices, though this does not happen perfectly in reality due to various constraints.

Empirical Evidence

• Leontief Paradox: U.S. exports were less capital-intensive than imports despite being capital-abundant.
• Studies across countries fail to fully support the strong predictions of the H-O model, especially when common technology assumptions are relaxed.

Summary of Key Points

1. Substitution of production factors creates a non-linear PPF.
2. Opportunity costs vary with production level changes.
3. Trade outcomes depend on relative factor endowments.
4. Gains from trade may be outweighed by income distribution effects, particularly for scarce factor owners.
5. The H-O model predictions about price equalization do not hold consistently in the real world, often due to technology differentials and trade barriers.
6. Suggests the need to balance compensation for trade losers while enabling overall economic growth through trade.

Conclusion

• Overall, the Heckscher-Ohlin model provides a framework for understanding international trade patterns but has limitations in empirical validation without accounting for technological differences and market disparities.