The Heckscher-Ohlin-Samuelson Theorem

• ECN 3891 • International Economics - Honors • Dr. Ali Moshtagh

The Classical and Neo-Classical Models of International Trade

• The Classical model of international trade is based on the “Labor Theory of Value”; it assumes only one factor of production, identical technology between the two countries, identical tastes, etc.. The model promotes specialization and requires complete specialization for at least one country, due to constant opportunity costs.

• Given a concave production possibilities frontier, international trade should lead to incomplete specialization, due to increasing costs.

• The Neo-Classical models of international trade assume more than one factor of production. The Heckscher-Ohlin-Samuelson model (also known as the Factor Endowment or the Variable Proportion Model) not only describes the pattern of trade, but it also predicts the impact of trade on the national income and returns to the factors of production.

Other Assumptions:

• two countries, two factors, two products; • perfect competition in all markets; • Free trade; • Factors of production are available in fixed amounts in each country; • Full mobility of factors of production between industries within each country; • Immobility of factors of production between countries; • The two countries are alike with respect to tastes; • Technology is available to both countries; and • Linear homogeneous production functions of degree one (constant returns to scale).

The Heckscher-Ohlin Theorem Critical Assumptions:

• Countries are characterized by different factor endowments--a country is capital abundant if it has a higher ratio of capital to other factors than does its trading partner; • There are different factor intensities between products--a product is capital-intensive if, at identical wages and rents, its production requires more capital per worker than does the other product.

The H-O Theorem

• Given identical production functions but different factor endowments between countries, a country will tend to export the commodity which is relatively intensive in her relatively abundant factor • In general, countries tend to have comparative advantage in the products that are relatively intensive in their relatively abundant factors

The Stolper-Samuelson Theorem:

Assumptions: • One country produces two goods (wheat and cloth) with two factors of production (capital and labor); • neither good is an input into the production of the other; • competition prevails; • factor supplies are given; • both factors are fully employed; • both factors are mobile between sectors (but not between countries); • one good (wheat) is capital-intensive and the other (cloth) is labor intensive); • opening trade raises the relative price of the export good.

The Stolper-Samuelson Theorem

• moving from no trade to free trade raises the returns to the factor used intensively in the rising-price industry, and lowers the returns to the factor used intensively in the falling-price industry, regardless of which goods the sellers of the two factors prefer to consume

The Factor Price Equalization Theorem

Assumptions: • there are two countries using two factors of production producing two products; • competition prevails in all markets; • each factor supply is fixed, and there is no migration between countries; • each factor is fully employed in each country with or without trade; • there are no transportation or information costs; • free trade; • production functions exhibit constant returns to scale, and are the same between countries for any industry; • production functions are not subject to factor intensity reversals; and • both countries produce both products with or without trade.

The Factor Price Equalization Theorem

• Free trade will equalize not only commodity prices but also factor prices, so that all workers earn the same wage rate and all units of capital will earn the same rental return in both countries regardless of the factor supplies or the demand patterns in the two countries

Hourly Pay in Manufacturing

Country Germany France Japan Taiwan Mexico Poland Hourly Pay (1990 U.S. = 100) 138 98 82 24 12 6

The Leontief Paradox

In 1953 Wassily Leontief published the results of the most famous empirical investigations in economics, an attempt to test the consistency of the H-O Model with the U.S. trade patterns.

Leontief’s objectives were to prove that: • the H-O Model was correct; and • to show that the U.S. exports were capital intensive

The Leontief Paradox

Leontief developed a 1947 input-output table for the U.S. to determine the capital-labor ratios used in the production of U.S. exports and imports. Leontief found that the U.S. exports used a capital-labor ratio of $13,991 per man year, whereas import substitutes used a ratio of $18,184 per man year.

The Leontief Paradox

The key ratio of [ ( K X / L X ) / ( K M / L M ) ] (13,991 / 1) / (18,184 / 1) = 0.77

was calculated. Given the presumption that the U.S. was relatively capital abundant, that ratio was just the reverse of what the H-O Model predicted. Thus, it is called the Leontief Paradox.

International Factor Mobility

Labor 0 1 2 3 4 5 6 7 8 9 10 11 Output 0 20 39 57 74 90 105 119 132 144 155 165 Marginal Product 20 19 18 17 16 15 14 13 12 11 10 In Home and Foreign there are two factors of production, land and labor, used to produce only one good.

The land supply in each country and the technology of production are exactly the same.

The marginal product of labor in each country depends on employment as shown in the Table.

Initially, there are 11 workers employed in Home, but only 3 in Foreign. Find the effects of free movement of labor from Home to Foreign on employment, production, real wages, and the income of land owners in each country.

Pre International Factor Mobility

Home: • Employment = 11 • Production = 165 • Real Wage Rate = 10 • Real Wages = 110 • Real Rent = 55 Labor 0 1 2 3 4 5 6 7 8 9 10 11 Output 0 20 39 57 74 90 105 119 132 144 155 165 Marginal Product 20 19 18 17 16 15 14 13 12 11 10

Pre International Factor Mobility

Labor 0 1 2 3 4 5 6 7 8 9 10 11 Output 0 20 39 57 74 90 105 119 132 144 155 165 Marginal Product 20 19 18 17 16 15 14 13 12 11 10 Foreign: • Employment = 3 • Production = 57 • Real Wage Rate = 18 • Real Wages = 54 • Real Rent = 3

Post International Factor Mobility

Home: • Employment = 7 • Production = 119 • Real Wage Rate = 14 • Real Wages = 98 • Real Rent = 21 Foreign: • Employment = 7 • Production = 119 • Real Wage Rate = 14 • Real Wages = 98 • Real Rent = 21

Effects of International Factor Mobility

Home: • Employment = 11 • Production = 165 • Real Wage Rate = 10 • Real Wages = 110 • Real Rent = 55 Home: • Employment = 7 • Production = 119 • Real Wage Rate = 14 • Real Wages = 98 • Real Rent = 21

Effects of International Factor Mobility

Foreign: • Employment = 3 • Production = 57 • Real Wage Rate = 18 • Real Wages = 54 • Real Rent = 3 Foreign: • Employment = 7 • Production = 119 • Real Wage Rate = 14 • Real Wages = 98 • Real Rent = 21