INTERNATIONAL TRADE: THEORY AND POLICY (HO) · Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers •The model was developed in 1919 by two Swedish economists, Eli

AA 2018-2019

PROF. PIERLUIGI [email protected]

INTERNATIONAL TRADE: THEORY AND POLICY (HO)

EU TRADE POLICY FOR DEVELOPMENT

JEAN MONNET CHAIR

KEY POINTS of the Ricardian Model

1. the pattern of trade is determined by comparative advantage.

• A country has comparative advantage in producing a good when the country’s opportunity cost of producing the good is lower than the opportunity cost of producing the good in another country.

• Even countries with poor technologies can export the goods in which they have comparative advantage

2. There are gains from trade for both countries.

• By exporting the good in which a country has the lowest opportunity cost, the country could benefit from participating in international trade (i.e. more consumption)

Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers

Repetita iuvant

Revealed comparative advantage

RCA index (Balassa, 1965). It is a ratio of

product k’s share in country i ’s exports (X) to its share in world trade.

A value of the RCA above 1 in sector k for country i means that i has a revealed comparative advantage in that sector (relative to the ROW)

Advantage: ability to derive a workable measure of each country’s comparative advantages as they are revealed in trade data, avoiding difficulties linked to quantitative evaluations of factor-endowments and relative prices.

Main drawback: just exports; asymmetric behavior between comparative advantagesand disadvantages. It ranges from 1 to infinity for products in which a country revealscomparative advantage, but only from zero to 1 for comparative disadvantage

The Heckscher-Ohlin Model

Why countries trade

An overview of trade theories:

The Heckscher-Ohlin Model

The Heckscher-Ohlin model assumes that trade occurs because countries have different resources.

The HO model is a long-run model because all factors of production can move across industries.

The model investigates also the gains from trade (i.e., the earnings of labor and capital in partner countries)

Heckscher-Ohlin Model


• The model was developed in 1919 by two Swedish economists, Eli Heckscher and BertilOhlin

• To explain the “golden age” of international trade between 1890 and 1914, during which there was an increase in the ratio of trade to gross domestic product (GDP)

• By assuming the same technologies acrosscountries they are able to explain trade by uneven distribution of resources

Examples of international trade driven by different resources


• Canada has a large amount of land and therefore exports agricultural and forestry products as well as petroleum

• US, Western Europe and Japan have many highly skilled workers and much capital and export sophisticated services and manufactured goods

• China and other Asian countries have a large number of workers and moderate but growing amounts of capital and export less sophisticated manufactured goods



Basic assumptions:

• 2 countries: Home and Foreign

• 2 goods: computers and shoes

• 2 factors of production: labor and capital

The total amount of capital (K) in an economy is given by the sum of the capitalused in shoes KS and computers KC.

The total available labor (L) in the economy is equal to the labor used in shoesLS and computers LC.

The SIX assumptions of the Heckscher-Ohlin model are the following:

Assumption 1: the two factors of production, labor and capital, can movefreely between the industries.

Assumption 2: Shoes production is labor-intensive; that is, it requires morelabor per unit of capital to produce shoes than computers, so that

LS /KS > LC /KC.


Assumption 3: Foreign is labor-abundant, by which we mean that the labor–capital ratio in Foreign exceeds that in Home, L*/K*> L/K.

Equivalently, Home is capital-abundant, so that K/L >K*/L* (i.e. resources differ across countries).

• Why?

• Geographic size, populations, immigration/emigration, different stage of development, etc.)

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 (the opposite of that in the Ricardian model).

Assumption 6: Consumer tastes are the same across countries, and preferences for computers and shoes do not vary with a country’s level of income.


PPFs

1 PF

Constant OC

2 PFs

Increasing OC

2 PFs

Decreasing

OC

X

100

100

100 100

100 100

20 20 20

80 80 80

20 80 75 95 5 40

A

B

A

B

A

B

Y

Pierluigi Montalbano – Università di Roma “La Sapienza”

Derivazione della Curva FPP in presenza di Fattori Specifici

Pierluigi Montalbano – Università di Roma “La Sapienza”

No-Trade EquilibriumProduction Possibilities Frontiers, Indifference Curves, and

No-Trade Equilibrium Price

FIGURE 4-2 (1 of 3)

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.


No-Trade Equilibria in Home and Foreign


The Home Country

FIGURE 3-2

Production Possibilities Frontier

Production Possibilities Frontier

The production possibilities frontier shows the amount of

agricultural and manufacturing outputs that can be produced in

the economy with labor.

© 2014 Worth Publishers International Economics, 3e | Feenstra/Taylor

14

Its slope equals –MPLA/MPLM, the ratio of the

marginal products of labor in the two industries. The

slope of the PPF can be interpreted as the opportunity

cost of the manufacturing output—it is the amount of

the agricultural good that would need to be given up

to obtain one more unit of output in the

manufacturing sector.

The Home Country

FIGURE 3-3

In the absence of international trade, the economy produces and consumes

at point A.

The relative price of manufactures, PM/PA, is the slope of the line tangent

to the PPF and indifference curve U1, at point A.

With international trade, the economy is able to produce at point B and

consume at point C.

The world relative price of manufactures, (PM/PA)W, is the slope of

the line BC.

The rise in utility from U1 to U2 is a measure of the gains from trade for

the economy.

Opportunity Cost and Prices


15

Increase in the Relative Price of Manufactures

Our goal is to show how:

The relative abundance of factors of a country determines both relative prices of goods and patterns of trade (H-O Model)

The opening of trade between two countries affects the payments to factors of production ( Stolper-Samuelson Theorem)




FIGURE 4-2 (2 of 3)

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.


No-Trade Equilibria in Home and Foreign (continued)




FIGURE 4-2 (3 of 3)

No-Trade Equilibria in Home and Foreign

(continued)

Foreign is labor-abundant and shoes are

labor- intensive, so the Foreign PPF is

skewed toward shoes.

Foreign preferences are summarized

by the indifference curve, U*

The Foreign no-trade equilibrium is at

point A*, with a higher relative price

of computers, as indicated by the

steeper slope of (P*C /P*S)A*.



A higher relative price of computers

Free-Trade EquilibriumHome Equilibrium with Free Trade

FIGURE 4-3 (1 of 2)

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.

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).

International Free-Trade Equilibrium at Home



Free-Trade EquilibriumHome Equilibrium with Free Trade

FIGURE 4-3 (2 of 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).

.

International Free-Trade Equilibrium at Home (continued)



Free-Trade EquilibriumForeign Equilibrium with Free Trade

FIGURE 4-4 (1 of 2)

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.

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).


International Free-Trade Equilibrium in Foreign


Free-Trade EquilibriumForeign Equilibrium with Free Trade

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).

.


International Free-Trade Equilibrium in Foreign (continued)


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 Heckscher-Ohlin theorem.



You might think that the H-O theorem is somewhat obvious. However, this prediction does not always work in practice

The first test of the Heckscher-Ohlin theorem was performed by economist Wassily Leontief in 1953 using data for the US from 1947.

A surprising conclusion!

From the HO theorem, Leontief expected that the United States would export capital-intensive goods and import labor-intensive goods.

What Leontief actually found, however, was just the opposite: the capital–labor ratio for U.S. imports was higher than the capital–labor ratio found for U.S. exports!

This finding contradicted the Heckscher-Ohlin theorem and came to be called Leontief’s paradox.

Testing the Heckscher-Ohlin Model


25

TABLE 4-1

Leontief used the numbers in this table to test the Heckscher-Ohlin theorem.

Each column shows the amount of capital or labor used in all industries needed to produce $1 million worth of exports from, or imports into, the United States in 1947.

As shown in the last row, the capital–labor ratio for exports was less than the capital–labor ratio for imports, which is a paradoxical finding.

Leontief’s Paradox

Leontief’s Test


Leontief’s 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 (US exports might have been agricultural products, which use land intensively)

■ 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.


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 capital-abundant 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.

Hence:

• Differences in factors productivity (technologies were not the same across countries)

• The pattern of 1947 simply reflects the high producivity of labor in the US and its abundance

• The US was abundant in both capital and (skilled) labor


To obtain better predictions from the H-O model, wehave to extend it in several directions:

1. first by allowing for more than two factors of production

2. and second by allowing countries to differ in theirtechnologies

Both extensions make the predictions match more closely the trade patterns we see in the world economy today…


Factor Endowments in the New Millennium

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 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.

2 Testing the Heckscher-Ohlin Model

Capital, Labor and Land Abundance

Factor Endowments in the New Millennium

FIGURE 4-6

Country Factor

Endowments, 2013

Shown here are

country shares of six

factors of production

in the year 2013, for

eight selected

countries and the rest

of the world.

In the first bar graph, we see that 24% of the world’s physical capital in 2013

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 2013 the United States

had 22% of world GDP, China had 11%, Japan had 8%, and so on.



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 capital-

abundant 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.



Measuring Factor Abundance Once Again To 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



Measuring Factor Abundance Once Again

To determine whether a country is abundant in a certain

factor, we compare the country’s 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.


E.g.: Effective R&D Scientists

Effective R&D scientists =

Actual R&D scientists • R&D spending per scientist

Differing Productivities across CountriesFIGURE 4-7 (1 of 2)

Shown here are country

shares of R&D scientists

and land in 2013, 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 2013 (since it had 14% of the world’s

R&D scientists as compared with 11% of the world’s GDP) but scarce in

effective R&D scientists (because it had 7% of the world’s effective R&D

scientists as compared with 11% of the world’s GDP).


“Effective” Factor Endowments, 2000

Differing Productivities across CountriesFIGURE 4-7 (2 of 2)

Shown here are country

shares of R&D scientists

and land in 2013, 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 world’s land as compared with 22% of the world’s GDP)

but neither scarce nor abundant in effective land (since it had 21% of the

world’s effective land, which nearly equaled its share of the world’s GDP).


“Effective” Factor Endowments, 2000

Leontief’s Paradox Once Again

FIGURE 4-8

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 world’s population, as

compared to 37% of the world’s

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 world’s effective labor as

compared to 37% of GDP, so it

was abundant in effective labor.

Labor Abundance


Labor Endowment and GDP for the United States and Rest of World, 1947

Leontief’s Paradox Once AgainLabor Productivity

FIGURE 4-9

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.


Labor Productivity and Wages

Leontief’s Paradox Once AgainLabor Productivity

FIGURE 4-9 (revisited)

As suggested by Figure 4-

9, 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.


Effective Labor Abundance

Effects of Trade on Factor Prices

How do the changes in the relative prices of goods due to tradeaffect the factors’ earnings?

• The Stolper-Samuelson Theorem provides an answer to the above question.

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 risesand the real wage in Home falls. In Foreign, the changes in real factor prices are just the reverse.

Effects of Trade on Factor Prices


1. In the Heckscher-Ohlin model countries trade because the available resources (labor, capital, and land) differ across countries.

2. In the Heckscher-Ohlin model, we assume that the technologies are the same across countries

3. The Heckscher-Ohlin model is a long-run framework, so labor, capital, and other resources can move freely between the industries

4. Patterns of trade: With two goods, two factors, and two countries, the Heckscher-Ohlin model predicts that a country will export the good that uses its abundant factor intensively and import the other good.

K e y T e r m KEY POINTS of the Heckscher-Ohlin model

K e y T e r m KEY POINTS of the Heckscher-Ohlin model

5. According to the Stolper-Samuelson theorem, in the long run, 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.

6. Putting together the Heckscher-Ohlin theorem and the Stolper-Samuelson theorem, we conclude that a country’s abundant factor gains from the opening of trade (because the relative price of exports goes up), and its scarce factor loses from the opening of trade.

Documents

INTERNATIONAL TRADE: THEORY AND POLICY (HO) · Book: Feenstra/Taylor, 2011 , International Trade,Worth Publishers •The model was developed in 1919 by two Swedish economists, Eli