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Trade and Resources: The Heckscher-Ohlin Model
4
1
2
Effects of Trade on
Factor Prices
4
Dickinson State University
Copyright 2011 Worth Publishers International Economics Feenstra/Taylor, 2/e.
Testing the
Heckscher-Ohlin
Model
3
Prepared by:
Fernando Quijano
Heckscher-Ohlin
Model
APPENDIX TO
CHAPTER 4
The Sign Test in the
Heckscher-Ohlin
Model
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Introduction
In this chapter, we outline the Heckscher-Ohlin
model, a model that assumes that trade occurs
because countries have different resources.
Our first goal is to describe the Heckscher-Ohlin (HO)
model of trade.
The specific-factors model that we studied in the
previous chapter was a short-run model because
capital and land could not move between the
industries.
In contrast, the HO model is a long-run model
because all factors of production can move
between the industries.
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Introduction
Our second goal is to examine the empirical evidence
on the Heckscher-Ohlin model.
By allowing for more than two factors of
production and also allowing countries to differ in
their technologies, as in the Ricardian model, the
predictions from the Heckscher-Ohlin model
match more closely the trade patterns in the
world economy today.
The third goal of the chapter is to investigate how the
opening of trade between the two countries affects the
payments to labor and to capital in each of them.
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1 Heckscher-Ohlin Model
Assumptions of the Heckscher-Ohlin Model
Assumption 1: Two factors of production, labor and
capital, can move freely between the industries.
Assumption 2: Shoe production is labor-intensive; that
is, it requires more labor per unit of capital to produce
shoes than computers, so that LS /KS > LC /KC.
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1 Heckscher-Ohlin Model
Labor Intensity of Each Industry The demand for labor relative
to capital is assumed to be higher in shoes than in computers,
LS/KS > LC/KC.
These two curves slope down just like regular demand curves,
but in this case, they are relative demand curves for labor (i.e.,
demand for labor divided by demand for capital).
FIGURE
4-1
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1 Heckscher-Ohlin Model
Assumptions of the Heckscher-Ohlin Model
Assumption 3: Foreign is labor-abundant, by which we
mean that the laborcapital ratio in Foreign exceeds that
in Home, L*/K*> L/K. Equivalently, Home is capitalabundant, so that K/L >K*/L*.
Assumption 4: The final outputs, shoes and computers,
can be traded freely (i.e., without any restrictions)
between nations, but labor and capital do not move
between countries.
Assumption 5: The technologies used to produce the
two goods are identical across the countries.
Assumption 6: Consumer tastes are the same across
countries, and preferences for computers and shoes do
not vary with a countrys level of income.
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APPLICATION
Are Factor Intensities the Same across
Countries?
While much of the footwear in the world is
produced in developing nations, the United
States retains a small number of shoe
factories.
Despite its nineteenth-century
exterior, this New Balance factory
in Maine houses advanced shoemanufacturing technology.
In India, the sewing machine used to produce
footwear is cheaper than the computer used in a call center. footwear
production in India is labor-intensive as compared with the call center,
which is the opposite of what holds in the United States.
This example illustrates a reversal of factor intensities between the
two countries.
In the United States, agriculture is capital-intensive. In many developing
countries, it is labor-intensive.
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1 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.
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1 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.
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1 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 is labor-abundant and shoes are Foreign preferences are summarized by
the indifference curve, U*
labor- intensive, so the Foreign PPF is
The Foreign no-trade equilibrium is at
skewed toward shoes.
point A*, with a higher relative price of
computers, as indicated by the steeper
slope of (P*C /P*S)A*.
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1 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.
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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).
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1 Heckscher-Ohlin Model
Free-Trade Equilibrium
Home Equilibrium with Free Trade
FIGURE 4-3 (2 of International Free-Trade Equilibrium at Home (continued)
2)
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).
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In panel (b), we show Home
exports of computers equal to zero
at the no-trade relative price,
(PC /PS)A,
and equal to (QC2 QC3) at the
free-trade relative price,
(PC/PS)W.
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1 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.
Copyright 2011 Worth Publishers International Economics Feenstra/Taylor, 2/e.
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).
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1 Heckscher-Ohlin Model
Free-Trade Equilibrium
Foreign Equilibrium with Free Trade
International Free-Trade Equilibrium in Foreign (continued)
FIGURE 4-4 (2 of 2)
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).
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In panel (b), we show Foreign imports
of computers equal to zero at the notrade relative price, (P*C /P*S)A*, and
equal to (Q*C3 Q*C2) at the freetrade relative price, (PC /PS)W.
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1 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 freetrade equilibrium.
FIGURE
Determination of the Free-Trade World Equilibrium Price
4-5
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).
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1 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 HeckscherOhlin theorem.
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2 Testing the Heckscher-Ohlin Model
The first test of the Heckscher-Ohlin theorem was
performed by economist Wassily Leontief in 1953.
Leontief supposed correctly that in 1947 the United States
was abundant in capital relative to the rest of the world.
Thus, from the Heckscher-Ohlin theorem, Leontief
expected that the United States would export capitalintensive goods and import labor-intensive goods.
What Leontief actually found, however, was just the
opposite: the capitallabor ratio for U.S. imports was
higher than the capitallabor ratio found for U.S. exports!
This finding contradicted the Heckscher-Ohlin theorem and
came to be called Leontiefs paradox.
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2 Testing the Heckscher-Ohlin Model
Leontiefs Paradox
TABLE 4-1
Leontiefs Test
Leontief used the numbers in this table to test the Heckscher-Ohlin
theorem. Each column shows the amount of capital or labor needed to
produce $1 million worth of exports from, or imports into, the United States
in 1947. As shown in the last row, the capitallabor ratio for exports was
less than the capitallabor ratio for imports, which is a paradoxical finding.
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2 Testing the Heckscher-Ohlin Model
Leontiefs Paradox
Explanations
U.S. and foreign technologies are not the same, in
contrast to what the HO theorem and Leontief assumed.
By focusing only on labor and capital, Leontief ignored
land abundance in the United States.
Leontief should have distinguished between skilled and
unskilled labor (because it would not be surprising to
find that U.S. exports are intensive in skilled labor).
The data for 1947 may be unusual because World War II
had ended just two years earlier.
The United States was not engaged in completely free
trade, as the Heckscher-Ohlin theorem assumes.
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2 Testing the Heckscher-Ohlin Model
Factor Endowments in the New Millennium
To determine whether a country is abundant in a certain
factor, we compare the countrys share of that factor with
its share of world GDP.
If its share of a factor exceeds its share of world GDP, then
we conclude that the country is abundant in that factor,
and if its share in a certain factor is less than its share of
world GDP, then we conclude that the country is scarce in
that factor.
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HEADLINES
China Drawing High-Tech Research from U.S.
For years, many of Chinas best and brightest left for the
United States, where high-tech industry was more cuttingedge.
But Mark R. Pinto is moving in the opposite direction.
Mr. Pinto is the first chief technology officer of a major
American tech company to move to China. Applied Materials,
is one of Silicon Valleys most prominent firms. It supplied
equipment used to perfect the first computer chips.
Not just drawn by Chinas markets, Western companies are
also attracted to Chinas huge reservoirs of cheap, highly
skilled engineers.
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2 Testing the Heckscher-Ohlin Model
Factor Endowments in the New Millennium
Capital, Labor and Land Abundance
FIGURE 4-6
Country Factor
Endowments, 2000
Shown here are
country shares of six
factors of production
in the year 2000, for
eight selected
countries and the rest
of the world.
In the first bar graph, we see that 24% of the worlds physical capital in 2000
was located in the United States, with 9% located in China, 13% located in
Japan, and so on. In the final bar graph, we see that in 2000 the United States
had 22% of world GDP, China had 11%, Japan had 8%, and so on.
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2 Testing the Heckscher-Ohlin Model
Differing Productivities across Countries
Remember that in the original formulation of the paradox,
Leontief had found that the United States was exporting
labor-intensive products even though it was capitalabundant at that time.
One explanation for this outcome would be that labor is
highly productive in the United States and less productive
in the rest of the world.
If that is the case, then the effective labor force in the
United States, the labor force times its productivity (which
measures how much output the labor force can produce),
is much larger than it appears to be when we just count
people.
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2 Testing the Heckscher-Ohlin Model
Differing Productivities across Countries
Measuring Factor Abundance Once To Again 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
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2 Testing the Heckscher-Ohlin Model
Differing Productivities across Countries
Measuring Factor Abundance Once Again
To determine whether a country is abundant in a certain
factor, we compare the countrys share of that effective
factor with its share of world GDP.
If its share of an effective factor exceeds its share of world
GDP, then we conclude that the country is abundant in
that effective factor; if its share of an effective factor is
less than its share of world GDP, then we conclude that
the country is scarce in that effective factor.
Effective R&D Scientists
Effective R&D scientists =
Actual R&D scientists R&D spending per scientist
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2 Testing the Heckscher-Ohlin Model
Differing Productivities across Countries
FIGURE 4-7 (1 of 2) Effective Factor Endowments, 2000
Shown here are country
shares of R&D scientists
and land in 2000, using
first the information from
Figure 4.6, and then
making an adjustment
for the productivity of
each factor across
countries to obtain the
effective shares.
China was abundant in R&D scientists in 2000 (since it had 14% of the worlds
R&D scientists as compared with 11% of the worlds GDP) but scarce in
effective R&D scientists (because it had 7% of the worlds effective R&D
scientists as compared with 11% of the worlds GDP).
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2 Testing the Heckscher-Ohlin Model
Differing Productivities across Countries
FIGURE 4-7 (2 of 2) Effective Factor Endowments, 2000
Shown here are country
shares of R&D scientists
and land in 2000, using
first the information from
Figure 4.6, and then
making an adjustment
for the productivity of
each factor across
countries to obtain the
effective shares.
The United States was scarce in arable land when using the number of acres
(since it had 13% of the worlds land as compared with 22% of the worlds GDP)
but neither scarce nor abundant in effective land (since it had 21% of the
worlds effective land, which nearly equaled its share of the worlds GDP).
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2 Testing the Heckscher-Ohlin Model
Differing Productivities across Countries
Effective Arable Land
TABLE 4-2 Food Trade and Total Agricultural Trade, 20002009
U.S.
This table shows that U.S. food trade has fluctuated between positive and
negative net exports since 2000, which is consistent with our finding that
the United States is neither abundant nor scarce in land. Total agriculture
trade (including nonfood items like cotton) has positive net exports,
however.
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2 Testing the Heckscher-Ohlin Model
Leontiefs Paradox Once Again
Labor Abundance
FIGURE 4-8Endowment and GDP for the United States and Rest of World, 1947
Labor
Shown here are the share of
labor, effective labor, and GDP
of the US and the rest of the
world in 1947. The US had only
8% of the worlds population, as
compared to 37% of the worlds
GDP, so it was very scarce in
labor. But when we measure
effective labor by the total
wages paid in each country,
then the United States had 43%
of the worlds effective labor as
compared to 37% of GDP, so it
was abundant in effective labor.
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2 Testing the Heckscher-Ohlin Model
Leontiefs Paradox Once Again
Labor Productivity
FIGURE 4-9
Labor Productivity and Wages
Shown here are estimated
labor productivities across
countries, and their
wages, relative to the
United States in 1990.
Notice that the labor and
wages were highly
correlated across
countries: the points
roughly line up along the
45-degree line.
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2 Testing the Heckscher-Ohlin Model
Leontiefs Paradox Once Again
Labor Productivity
FIGURE 4-9 (revisited)
Effective Labor Abundance
As suggested by Figure 49, wages across countries
are strongly correlated
with the productivity of
labor. We use the wages
earned by labor to
measure the productivity
of labor in each country.
Then the effective amount
of labor found in each
country equals the actual
amount of labor times the
wage.
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3 Effects of Trade on Factor Prices
Effect of Trade on the Wage and Rental of Home
Economy-Wide Relative Demand for Labor
FIGURE 4-Determination of Home Wage/Rental
10
The economy-wide relative
Relative
supply
Relative
demand
demand for labor, RD, is an
average of the LC /KC and LS
/KS curves and lies between
these curves.
The relative supply, L/K, is
shown by a vertical line because
the total amount of resources in
Home is fixed.
The equilibrium point A, at which
relative demand RD intersects
relative supply L/K, determines
the wage relative to the rental,
W/R.
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3 Effects of Trade on Factor Prices
Effect of Trade on the Wage and Rental of Home
Increase in the Relative Price of Computers
FIGURE 4Increase in the Price of Computers
11
Initially, Home is at a no-trade
equilibrium at point A pwith a
relative price of computers of
(PC /PS)A.
An increase in the relative
price of computers to the
world price, as illustrated by
the steeper world price line,
(PC /PS)W, shifts production
from point A to B.
At point B, there is a higher
output of computers and a
lower output of shoes, QC2 >
QC1 and QS2 < QS1.
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3 Effects of Trade on Factor Prices
Effect of Trade on the Wage and Rental of Home
Increase in the Relative Price of Computers
FIGURE 4-12 (1 of 2) of a Higher Relative Price of Computers on Wage/Renta
Effect
An increase in the
relative price of
computers shifts the
economy-wide relative
demand for labor, RD1,
toward the relative
demand for labor in the
computer industry, LC
/KC.
The new relative demand
curve, RD2, intersects
the relative supply curve
for labor at a lower
relative wage, (W/R)2.
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3 Effects of Trade on Factor Prices
Effect of Trade on the Wage and Rental of Home
Increase in the Relative Price of Computers
FIGURE 4-12 (2 of 2)
Effect of a Higher Relative Price of Computers on
Wage/Rental (continued)
As a result, the wage
relative to the rental falls
from (W/R)1 to (W/R)2.
The lower relative wage
causes both industries to
increase their labor
capital ratios, as
illustrated by the
increase in both LC /KC
and LS /KS at the new
relative wage.
Relative supply
No change
Relative demand
No change in total
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3 Effects of Trade on Factor Prices
Determination of the Real Wage and Real Rental
Change in the Real Rental
R = PC MPKC and R = PS MPKS
MPKC = R/PC and MPKS = R/PS
Change in the Real Wage
W = PC MPLC and W = PS MPLS
MPLC = W/PC and MPLS = W/PS
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3 Effects of Trade on Factor Prices
Determination of the Real Wage and Real Rental
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.
For our example, the Stolper-Samuelson theorem
predicts that when Home opens to trade and faces a
higher relative price of computers, the real rental on
capital in Home rises and the real wage in Home falls. In
Foreign, the changes in real factor prices are just the
reverse.
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3 Effects of Trade on Factor Prices
Changes in the Real Wage and Rental: A Numerical Example
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3 Effects of Trade on Factor Prices
Changes in the Real Wage and Rental: A Numerical Example
General Equation for the Long-Run Change in Factor Prices The
long-run results of a change in factor prices can be summarized in
the following equation:
Real
wage
falls
Real
rental
increase
The equations relating the changes in product prices to changes in
s
factor prices are sometimes called the magnification effect because
they show how changes in the prices of goods have magnified effects
on the earnings of factors:
Real
rental
falls
Real
wage
increas
es
Real
rental
falls
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Real
wage
increas
es
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APPLICATION
Opinions toward Free Trade
According to the specific-factors model, in the short run we
do not know whether labor will gain or lose from free trade,
but we do know that the specific factor in the export sector
gains, and the specific factor in the import sector loses.
We would expect that workers in export industries will
support free trade (since the specific factor in that industry
gains), but workers in import-competing industries will be
against free trade (since the specific factor in that industry
loses).
In the short run, then, the industry of employment of
workers will affect their attitudes toward free trade.
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APPLICATION
Opinions toward Free Trade
In the long-run Heckscher-Ohlin model, however, the
industry of employment should not matter.
According to the Stolper-Samuelson theorem, an increase
in the relative price of exports will benefit the factor of
production used intensively in exports and harm the other
factor, regardless of the industry in which these factors of
production actually work.
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APPLICATION
Opinions toward Free Trade
An increase in the relative price of exports will benefit skilled
labor in the long run, regardless of whether these workers
are employed in export-oriented industries or importcompeting industries.
In the long run, then, the skill level of workers should
determine their attitudes toward free trade.
In a survey conducted in the United States by the National
Elections Studies (NES) in 1992, workers with lower wages
or fewer years of education are more likely to favor import
restrictions, whereas those with higher wages and more
years of education favor free trade.
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K P PyE NT e X mO
Ae
DI r T
CHAPTER 4
The Sign Test in the Heckscher-Ohlin Model
Measuring the Factor Content of Trade
FIGURE
4A-1
Factor Content of Trade for the United States, 1947 This table
extends Leontiefs 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.
By taking the difference between the factor content of exports and the
factor content of imports, we obtain the factor content of net exports, shown
in the final column of Table 4A-1.
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K P PyE NT e X mO
CHAPTER 4
The Sign Test in the Heckscher-Ohlin Model
The Sign Test
We make use of the factor content of trade in developing a
test for the Heckscher-Ohlin model, called the sign test.
This test states that if a country is abundant in an effective
factor, then that factors content in net exports should be
positive, but if a country is scarce in an effective factor,
then that factors content in net exports should be negative.
Sign of (countrys % share of effective factor % share of world GDP)
= Sign of countrys factor content of net exports
Copyright 2011 Worth Publishers International Economics Feenstra/Taylor, 2/e.
e R dna eda T: 4 r e pah C
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CHAPTER 4
The Sign Test in the Heckscher-Ohlin Model
The Sign Test in a Recent Year
FIGURE
The 4A-2 Test for 33 Countries with Differing Technologies, 1990 This table
Sign
shows the sign test for the Heckscher-Ohlin model for 1990, allowing for
different technologies across countries. There are 33 countries included in
the study and 9 factors of production. All countries have more factors
passing the sign test than failing it, especially the low- and medium-income
countries. These results show that the sign test holds true when we allow
productivities to differ across countries.
Note: The countries with low GDP per capita are Bangladesh, Pakistan, Indonesia, Sri Lanka, Thailand,
Colombia, Panama, Yugoslavia, Portugal, and Uruguay. The countries with middle GDP per capita are
Greece, Ireland, Spain, Israel, Hong Kong, New Zealand, and Austria. The countries with high GDP per
capita are Singapore, Italy, the United Kingdom, Japan, Belgium, Trinidad, the Netherlands, Finland,
Denmark, former West Germany, France, Sweden, Norway, Switzerland, Canada, and the United States.
Copyright 2011 Worth Publishers International Economics Feenstra/Taylor, 2/e.