Heckscher-Ohlin Model PDF

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TRADE AND RESOURCES: Heckscher-Ohlin
THE HECKSCHER-OHLIN Model
2
MODEL Effects of Trade on
Factor Prices
3
Extending the
Heckscher-Ohlin
Model
4
Conclusions
Chapter Outline
•  Introduction
•  Heckscher-Ohlin Model
  Assumptions
  No-Trade Equilibrium
  Free Trade Equilibrium
  Testing the Heckscher-Ohlin theorem: Leontief’s
Paradox
•  Effects of Trade on Factor Prices
  Effect of Trade on the Wage and Rental of Home
  Determination of the Real Wage and Real Rental
  Changes in the Real Wage and Rental: A Numerical
Example
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

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Chapter Outline
•  Extending the Heckscher-Ohlin Model

  Many Goods, Factors and Countries
  Differing Productivities Across Countries
  Extending the Heckscher-Ohlin Theorem
•  Conclusions

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Learning Objectives
•  Understand the Heckscher-Ohlin Model.

•  Understand how the HO Model contrasts with the
Ricardian model.
•  Understand the assumptions of the HO Model and
how they affect the model.
•  Understand the No-Trade and the Free Trade
equilibrium of the HO model.
•  Understand Leontief’s Paradox and its tie to the
HO Model.
•  Understand the effects of trade on factor prices.

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Learning Objectives
•  Understand how the real wage and the real rental
rate of capital are determined.
•  Understand how we can extend the Heckscher-
Ohlin model.
•  Understand how using many goods, factors, and
countries changes the predictions of the HO
model.
•  Understand how differing productivities across
countries affects the HO model and how that
compares to the Leontief paradox.
•  Understand how the HO theorem can be
extended.

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Introduction
•  In this chapter we outline the Heckscher-Ohlin
model.
•  The Heckscher-Ohlin model (HO) shows how
trade occurs because countries have different
resources.
•  The model was developed at the end of the
“golden age” of international trade which saw
dramatic improvements in transportation.
•  They wanted to explain this increase in trade.
•  H-O assumed that technologies were the same
across countries, but had an uneven distribution
of resources.

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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.
•  We will examine the empirical evidence on the HO model.
•  To obtain better predictions from the HO model, we will
extend the model to allow for more than two goods and
more than two factors.
•  We will also allow the model to incorporate countries with
differing technologies.

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Heckscher-Ohlin Model
•  There are two countries, Home and Foreign.

•  Each country produces two goods, computers and
shoes.
•  Production uses two factors of production, labor
(L) and capital (K).
•  We can add up the resources used in each
industry to get the total for the economy.
  Capital in each good for each country
  K = KC + KS and K* = K*C + K*S
  Labor in each good for each country
  L = LC + LS and L* = L*C + L*S

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Assumptions of the Heckscher-Ohlin Model
1.  Both factors can move freely between industries.

  Capital must earn the same rental rate, R, in both
industries.
  All labor earns the same wage in both industries.
  If not, then capital or labor would move to the industry
where it received the higher rate.

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2.  Shoe production is labor-intensive; it requires

more labor per unit of capital to produce shoes
than computers, so that LS/KS > LC/KC.
  Computer production is capital-intensive—more
capital per worker is used to produce computers than
to produce shoes.
  Shoes use more labor per unit of capital.
  Figure 4.1 shows relative demand curves for labor in
each industry.
  Because shoe production is more labor intensive, the relative
demand curve for shoes lies to the right of the labor demand
for computers.

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Figure 4.1

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3.  Foreign is labor abundant; the labor-capital ratio

in Foreign exceeds that in Home. 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, but accept the
differences as important determinants of why
countries engage in trade.
  We focus on a particular case where Foreign is labor
abundant and Home is capital abundant.

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4.  The final outputs, shoes and computers, can be

traded freely, without restrictions, between
nations, but labor and capital do not move
between countries.
  We do not allow labor or capital to move between
countries.
  This assumption will be related in the next chapter.

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5.  The technologies used to produce the two goods

are identical across the countries.
  This is opposite of the assumption in the Ricardian
model.
  It is not a realistic assumption, but it allows us to focus
on a single reason for trade—the different amounts of
labor and capital.
  We will test the validity of the HO model and find it
performs better when this assumption is not used.

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6.  Consumer tastes are the same across countries,

and preferences for computers and shoes do not
vary with a country's level of income.
  A poorer country will buy less of both shoes and
computers, but in the same ratio as a wealthier
country facing the same prices.
  Again, although not a very realistic assumption, it
allows us to focus attention on the differences in
resources as the sole reason for trade.

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Are Factor Intensities the Same Across Countries?
APPLICATION

•  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
•  This assumption is not as obvious when
comparing other industries such as shoes and call
centers.
•  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.

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APPLICATION

•  While the U.S. still produces some shoes, the production
is different from the production in Asia.
•  The Asian production uses old technology and workers
earn relatively little compared to the U.S., so they use
more workers to operate less productive machines.
•  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.

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APPLICATION

•  We can also see this reversal of factor intensities when
comparing agricultural sectors across countries.
•  In the U.S. agriculture is capital intensive, but in India it is
labor intensive.
  Capital is relatively cheaper in the U.S..
  Labor is relatively cheaper in India.
•  However, our assumption is that the labor-capital ratio (L/
K) exceeds that of the other country in an industry
regardless of the wage rental ratio (W/R).
•  In the HO model, we will ignore the possibility of “factor
intensity reversals.”

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No Trade Equilibrium
•  We are going to use the differences in resources
to predict the pattern of trade.
•  We begin by looking at the equilibrium that exists
in each country without trade.
•  Production Possibility Frontiers
  Home is capital abundant and computer production is
capital intensive.
  Home is capable of producing more computers than
shoes.
  Foreign is labor-abundant and shoe production is
labor-intensive.
  Foreign is capable of producing more shoes.

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Production abilities for Home and Foreign given
factor abundances
Q of Q of
Shoes, Relative Price of Shoes,
QS Computers, QS
slope = (PC/PS)A
A*
Q*S1
Relative
A Price of
QS1
Computers,
slope =
(P*C/P*S)A*
QC1 Q*C1 Q of Computers,

Q of Computers,
QC
QC
a) Home b) Foreign
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 20 of 113

•  Indifference Curves
  Consumer tastes are the same across countries, so the shape
of the indifference curves is the same in each country.
  The tangencies with the two countries’ PPFs are different
because of the different shapes of the PPFs.
  When the indifference curves are tangent to the PPF, the
slopes are equal.
  The relative price that consumers are willing to pay for computers
equals the opportunity cost of producing them—the no trade
equilibrium.
  The slope at tangency equals the relative price of computers
—the steeper the slope, the higher the relative price of
computers.

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•  No Trade Equilibrium Price
  Different relative prices exist in each country because
of the different shapes of the PPFs.
  At Home, the slope of the Home price line (PC/PS)A is
quite flat.
  Low relative price of computers.
  In Foreign, the slope of the price line (P*C/P*S)A* is quite
steep.
  High relative price of computers.
  The no-trade relative price of computers at Home is
lower than in Foreign.
  The no-trade relative price of shoes at Home is higher
than in Foreign.

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Figure 4.2 No-Trade Equilibria in Home and Foreign

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•  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.
  The no-trade relative price of shoes is lower in Home.

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Free Trade Equilibrium
•  First, we consider what happens when the world
relative price of computers is above the no-trade
relative price of computers at Home.
  Trace out the Home export supply of computers.
•  Second, we consider what happens when the
world relative price is below the no-trade relative
price of computers in Foreign.
  Trace out the Foreign import demand for computers.
•  Finally, we put together the Home export supply
and the Foreign import demand to determine
equilibrium relative price of computers with trade.

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•  Home Equilibrium with Free Trade

  Under free trade, we expect the equilibrium relative
price of computers to lie in between the no-trade
relative prices in each country.
  The Home PPF will show a free trade or world relative
price of computers that is higher than the no-trade
Home relative price.
  Home production moves based on the new relative
price of computers—Point A to Point B.
  They will produce more computers and fewer shoes.
  Home specializes further in computers.

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•  Home can now consume on any point along the world
price line through point B (next slide).
•  The highest utility is obtained at point C, where the
indifference curve is tangent to the world price line.
  Consume QC3 and QS3 while producing QC2 and QS2
•  We can now define the Home “trade triangle,” which is the
triangle that connects points B and C.
•  B is where Home produces and C is where Home
consumes.
•  The base of the triangle is the Home exports of computers.
•  The height of the triangle is the Home imports of shoes.

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Figure 4.3

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•  We can use the Home trade information to graph

the exports of computers against the relative
price.
  At the no-trade price of (PC/PS)A, exports are 0.
  Point A (next slide)
  At the world price of (PC/PS)W, exports are QC2 - QC3.
  Point D (next slide)
  This gives the Home export supply curve for
computers.
  It is upward-sloping since at higher relative prices,
Home is willing to specialize further in computers and
export more of them.

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Figure 4.3

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•  Foreign Equilibrium with Free Trade

  Under free trade, we expect the equilibrium relative
price of computers to lie in between the no-trade
relative prices in each country.
  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 production moves from Point A* to B* with
more shoes and fewer computers.
  Foreign specializes further in shoes and produces fewer
computers.

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•  Foreign can now consume on any point along the world
price line through point B*.
•  The highest utility is obtained at point C*, where the
indifference curve is tangent to the world price line.
  Consume Q*C3 and Q*S3 while producing Q*C2 and Q*S2
•  We can now define the Foreign “trade triangle” which is
the triangle that connects points B* and C*.
•  B* is where Foreign produces and C* is where Foreign
consumes.
•  The base of the triangle is the Foreign imports of
computers.
•  The height of the triangle is the Foreign exports of shoes.

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Figure 4.4

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•  We can use the Foreign trade information to
graph the import of computers against the relative
price.
  At the free trade price of (P*C/P*S)A, exports are 0.
  Point A* (next slide)
  At the world price of (P*C/P*S)W, imports are QC*2 - QC*3.
  Point D* (next slide)
  This gives the Foreign import demand curve for
computers.
  It is downward-sloping since at higher relative prices,
Foreign is willing to specialize further in shoes and
import more computers.

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Figure 4.4

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•  Equilibrium Price with Free Trade

  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.
  The trade triangles of the two countries are identical in
size.

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Figure 4.5

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•  Pattern of Trade
  Home exports computers—the good that uses their
abundant factor of production intensively—capital.
  Foreign exports shoes—the good that uses their
abundant factor of production intensively—labor.
  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.

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•  Review of the Assumptions of the Heckscher-

Ohlin Model.
  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.

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•  Review of the Assumptions of the Heckscher-

Ohlin Model
  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.

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•  Assumptions 1–3 allowed us to draw the PPF of

the two countries.
•  Combining with assumptions 5 and 6, we
determined the no-trade relative price of
computers. It was lower in Home.
•  This allowed us to determine the starting points
for the Home export supply curve and the Foreign
import demand curve.
•  The relative price of computers in free trade must
lie between the no-trade relative prices.

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•  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.
  The relative price of computers in Foreign falls from the
no-trade 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
•  This may all seem obvious—let’s test it

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•  Testing the Heckscher-Ohlin 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 is in Table 4.1 which also shows the capital/
labor ratio in dollars per person.

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Leontief’s Test

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•  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.

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•  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.
  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.

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•  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.

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•  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.

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•  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.

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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.

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•  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.

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•  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.
Relative Supply
Relative Demand

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•  The relative demand is a weighted average of the

labor-capital ratio to each industry.
  This weighted average is obtained by multiplying the
labor-capital 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.

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•  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.
•  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.

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Figure 4.6

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•  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.

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•  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.
  The relative demand curve shifts left from RD1 to RD2.
  Shifts in the direction of computers.
  Equilibrium moves from point A to B.

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The real
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change the amount
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relative ofof
causes
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shift left—toward
Figure 4.8

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•  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.

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•  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.
Relative Supply

No change

Relative Demand

No change in total


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•  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.

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•  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.

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•  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.

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  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.
  Therefore, capital owners are clearly better off when
the relative price of capital increases.

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  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.

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•  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

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•  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.

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•  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.

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•  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

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•  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%

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•  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:

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•  Since the price of

computers has risen,
ΔPC > 0 and ΔPS = 0.
•  Using this in the last
equations:

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•  We can rewrite the last equation in percentage

changes:

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•  Plugging in data from before
•  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

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•  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.

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•  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.

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•  General Equation for the Long-Run Change in

Factor Prices
  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

77 of 113
•  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.

78 of 113
Extending the Heckscher-Ohlin Model
•  We need to make the HO model 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.

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•  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?

80 of 113

  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.
  This gives factor content of net exports, shown in the final
column of 4.2.

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Factor Content of Trade for the United States, 1947

82 of 113

  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.

83 of 113
•  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.

84 of 113
Country Factor Endowments, 2000 Figure 4.9

85 of 113
•  Capital Abundance
  We can use the data in figure 4.9.
  For example, 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.

86 of 113
•  Capital Abundance
  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.

87 of 113
•  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.

88 of 113
•  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.

89 of 113
•  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
model.

90 of 113
•  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.

91 of 113
•  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.

92 of 113
•  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 4.9
using figure 4.10
  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.

93 of 113
“Effective” Factor Endowments, 2000 Figure 4.10

94 of 113
Food Imports Close to Matching
Level of Exports
HEADLINES
•  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.

95 of 113
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.
  If a country is scarce in an effective factor, then that
factor’s content in net exports should be negative.

96 of 113
•  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).
  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.

97 of 113
•  The Sign 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.

98 of 113
•  One way to measure productivity is to use wages

paid to workers.
•  A plot of wages of workers in various countries
and the estimated productivity of workers in 1990
is shown in figure 4.11.
  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.

99 of 113
Figure 4.11

100 of 113
•  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.

101 of 113
Conclusions
•  The HO framework is one of the most widely used

models in explaining trade patterns.
•  It 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 also provides clear
guidance as to who gains and who loses from
trade.

102 of 113
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.

103 of 113
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.

104 of 113

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4

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Extending the Heckscher-Ohlin Model

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Understand the Heckscher-Ohlin Model.

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• There are two countries, Home and Foreign.

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

1. Both factors can move freely between industries.

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

2. Shoe production is labor-intensive; it requires

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

3. Foreign is labor abundant; the labor-capital ratio

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

4. The final outputs, shoes and computers, can be

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

5. The technologies used to produce the two goods

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

6. Consumer tastes are the same across countries,

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

QC1 Q*C1 Q of Computers,

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor 20 of 113

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• No Trade Equilibrium Price

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Home Equilibrium with Free Trade

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• We can use the Home trade information to graph

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Foreign Equilibrium with Free Trade

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Equilibrium Price with Free Trade

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Review of the Assumptions of the Heckscher-

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Review of the Assumptions of the Heckscher-

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Assumptions 1–3 allowed us to draw the PPF of

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• When trade opens:

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• Testing the Heckscher-Ohlin Theorem: Leontief’s

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

• It was impossible for Leontief to get information on

•  Extending the Heckscher-Ohlin Model

•  Understand the Heckscher-Ohlin Model.

•  There are two countries, Home and Foreign.

1.  Both factors can move freely between industries.

2.  Shoe production is labor-intensive; it requires

3.  Foreign is labor abundant; the labor-capital ratio

4.  The final outputs, shoes and computers, can be

5.  The technologies used to produce the two goods

6.  Consumer tastes are the same across countries,

•  No Trade Equilibrium Price

•  Home Equilibrium with Free Trade

•  We can use the Home trade information to graph

•  Foreign Equilibrium with Free Trade

•  Equilibrium Price with Free Trade

•  Review of the Assumptions of the Heckscher-

•  Review of the Assumptions of the Heckscher-

•  Assumptions 1–3 allowed us to draw the PPF of

•  When trade opens:

•  Testing the Heckscher-Ohlin Theorem: Leontief’s

•  It was impossible for Leontief to get information on

•  Leontief assumed correctly that in 1947 the U.S.

•  Why would this paradox exist?

•  Several of the explanations depend on having

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

•  Effect of Trade on the Wage and Rental of Home

•  Economy-Wide Relative Demand for Labor

•  The relative demand is a weighted average of the

•  The relative demand is an average of the labor

•  Increases in the Relative Price of Computers

•  Increases in the Relative Price of Computers

•  From this, the labor-capital ratio rises in both

•  We can use our earlier equation for relative

•  Determination of the Real Wage and Real Rental.

•  Change in the Real Rental

•  Change in the Real Rental

•  Change in the Real Rental

•  Change in the Real Wage

•  Change in the Real Wage

•  The Stolper-Samuelson Theorem:

•  Changes in the Real Wage and Rental: A

•  Shoes are more labor-intensive than computers.

•  Since the price of

•  We can rewrite the last equation in percentage

•  Plugging in data from before

•  Our goal is to find out by how much rental

•  After solving we get:

•  We can also see:

•  General Equation for the Long-Run Change in

•  These equations relating the changes in product

•  We need to make the HO model more realistic by

•  Many Goods, Factors, and Countries

•  Measuring the Factor Content of Trade

•  Measuring the Factor Content of Trade