Trade Models: Extensions and Applications
• Factor Endowment Theory (Heckscher – Ohlin)
– Does it work?
• Leontief Paradox
• Factor Price Equalization (Stolper-Samuelson)
– Does it happen?
• Globalization and its discontents
• U.S. income distribution: the gulf widens
• Intra-industry trade
• Product differentiation and trade
» Overlapping demands
» Increasing returns to scale
» Product life-cycle
• Supply – Demand Model of Trade: Buy Low Sell High
• Price convergence
• Transportation costs price wedge
Factor Endowment Theory
(Heckscher – Ohlin)
• Focus on Supply:
– Technology and input factors: labor, capital, land (natural
resources)
• Assume: everyone uses the same technologies to make things.
– Also assume competitive factor markets: within each country, the factor’s
“wage” is the same in all industries.
• Then: a nation has comparative advantage in things that use a
lot of its relatively abundant and cheap factor.
Also assume everyone has roughly the same tastes.
• Then: a nation exports things that use a lot of its relatively
abundant and cheap factor.
Factor endowments of countries & regions, as a percentage of the world total
Capital
Skilled Labor
Unskilled Labor
All Resources
20.8%
19.4%
2.6%
5.6%
European Union
20.7
13.3
5.3
6.9
Japan
10.5
8.2
1.6
2.9
Canada
2.0
1.7
0.4
0.6
Mexico
2.3
1.2
1.4
1.4
China
8.3
21.7
30.4
28.4
India
3.0
7.1
15.3
13.7
Hong Kong, South Korea, Taiwan, Singapore
2.8
3.7
0.9
1.4
Eastern Europe, including Russia
6.2
3.8
8.4
7.6
OPEC
6.2
4.4
7.1
6.7
Rest of the world
17.2
15.5
26.6
24.8
Total
100.0
100.0
100.0
100.0
United States
Source: Wm. R. Cline,Trade and Income Distribution, IIE, 1997, pp. 183 -185
Heckscher-Ohlin, skills, and comparative advantage
Education:Land Area
Leonief Paradox?
•For US (~1950) (Capital/labor)Export Industries < (Capital/labor)Import Competing Industries
 Explanation: Considering human capital, US is “labor” abundant
Education, skill intensity, and U.S. import shares, 1998
Factor Price Equalization
• A nation exports things that use a lot of its relatively
abundant and cheap factor.
– In the exporting country, demand for this abundant factor
increases.
• The wage of the abundant factor increases.
– In the importing country, where this factor is scarce and
expensive, demand for this factor decreases.
• The wage of the scarce and expensive factor decreases.
• The factor’s wage is equalized in the exporting and
importing countries.
»Trade substitutes for factor flows.
• There are winners and losers from trade
• Specific factor issues:
Factor specific to an import-competing industry loses big from trade
Indexes of hourly compensation, manufacturing workers,
2006 (U.S.=100)
Not all “labor” is equal
Does Factor Price Equalization Theory Work?
• In US, skilled workers are relatively abundant.
• Skilled worker wages are relatively low in US
TRADE  Rich get richer in US.
Poor get poorer.
– Widened gap between skilled and unskilled wages in US
explained in part, but small part, by globalization.
• Increased importance of education/human capital in high-tech economy
• But globalization disciplines all workers
• Outsourcing of high-skilled jobs: Indian engineers/computer scientists
Human capital/productivity gaps  Wage differences persist
• Productivity is both individual and social
– Rule of law/The human capital of your co-worker
• Labor not only factor subject to competitive pressures
• Globalization disciplines all factors
Much trade is in imports and exports of roughly the same kinds of goods
Index of Intraindustry Trade:
(Exports/Imports)
US Industries, 1993 & 2007
Inorganic chemicals
.99
Power-generating machinery
.97/.99
Electrical machinery
.96/.72
Organic chemicals
.91
Medical and pharmaceutical
.86
Office machinery
.81
Telecommunications equipment .69
Road vehicles
.65
Iron and steel
.43
Clothing and apparel
.27
Footware
.00/.00
Ex/Im
.43
3.8
.79
.72
.44
1.5
1.4
.34
Trade Models: Extensions and Applications
Intraindustry Specialization & TradeIncreasing Returns
– Dynamic Comparative Advantage
• Industrial Policy: Promote champions?
• Theory of Overlapping Demand
• Product Life Cycle Model
• Supply – Demand Model of Trade
• Environmental Protection and Costs
• Transportation Costs
Theory of Overlapping Demands
• Most US trade in manufactures is with other rich nations.
• Linder: countries with similar incomes have similar tastes and
patters of demand.
• Firms first establish themselves in home market.
• Firms find foreign markets where demands overlap.
Product Life Cycle Theory…Think Gaming
• Good is
introduced in home market
•Technological breakthrough/Specialized inputs/High Risk Small scale/Local Mkt
•Success/growth/cost reduction
•Domestic industry exports the good
•Production becomes routine
•Foreign production begins
•Domestic industry loses competitive advantage
•Import competition begins
•Observe both exports and imports of same stuff
Intraindustry Trade: Import and Export the “Same” Thing
Homogeneous products
 Transport savings near borders
 Seasonal reasons
Differentiated products
 Focus on particular product in industry
Exploit economies of scale
Serve domestic “majority” and overlapping foreign
demand
Explaining trade patterns: Summary
• Comparative advantage owing to factor endowments
 Net exports by industry (“Interindustry” trade)
• Product differentiation and economies of scale
 Intraindustry trade
– Similar endowments – Similar tastes
– Product Life Cycle: Technology evolves from breakthrough to routine
• What you export/What you import  History and accident
Supply – Demand Model of Trade
In the absence of trade, the same good will sell
for different prices in different places.
An opportunity presents itself:
BUY LOW – SELL HIGH
Free trade under increasing costs
No transportation costs
Transportation costs
Free trade under increasing costs
Transportation costs of $2000 per auto
Supply – Demand Model of Trade
If there are increasing costs
Cost and price in the exporting country increases
Cost and price in the importing country decreases
Cost and price in the two countries converge.
Trade effects of government regulation
e.g., Environmental Standards
Supply and Demand of Calculators
Sweden
Norway
Price
Quantity
Supplied
Quantity
Demanded
$0
5
10
15
20
25
30
35
40
45
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
1,200
1,000
800
600
400
200
0
0
0
0
Price
Quantity
Supplied
Quantity
Demanded
$0
5
10
15
20
25
30
35
40
45
0
0
0
0
200
400
600
800
1,000
1,200
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0