Transcript Specialization based on relative factor

TAMÁS NOVÁK
International Economics III.
Specialization based on
relative factor-endowment
(The Heckscher-Ohlin
Model)
Readings
–
PAUL KRUGMAN – MAURICE OBSFELD:
International Economics. Theory and Practice.
Chapter 4.
Specialization based on relative factorendowment
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Ricardian model: comparative advantage
arise only because of differences in labor
productivity.
Trade reflects differences in countries’
resources.
Hechscher-Ohlin
model
shows
that
comparative advantage is influenced by the
relative abundance of factors of production
(and the technology of production)
Specialization based on relative factorendowment
Let’s take a look at this table:
K (billion $)
L (million persons)
Country A
200
100
Country B
40
80
We can see that country A is more abundant in both
capital and labour than country B. According to the
theory of comparative advantages country A is
relatively capital-abundant compared with country
B, while country B is relatively labour-abundant
compared with country A.
Specialization based on relative factorendowment
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Comparative advantages come from the capital/labor
ratio (K/L), which is 2000 in case of country A, and
500 in case of country B.
From the fact that one country is relatively abundant
in one factor follows that the other country is relatively
abundant in the other factor.
Now we would like to know the direction of
specialization between a relatively labor-abundant
and a relatively capital-abundant country.
Specialization based on relative factorendowment
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Sometimes it is difficult to compare the
absolute quantity of labor and capital of
different countries.
We can substitute labor and capital for the
price of them. The price of labor is wage, (w)
and that of capital is interest rate (i).
We can assume that the ratio of interest
rate/wage will be lower in a relatively capitalabundant country, and will be higher in a
relatively labor-abundant country.
Specialization based on relative factorendowment
Though there is no strict relationship either between the
absolute quantity of capital and interest rate or the absolute
quantity of labor and wages, we can expect that in a relatively
capital-abundant country the interest rate/wage ratio will be
lower than in a relatively labor-abundant country. In our
example the rates of interest and wages are as follows:
i (%)
w (thousand $)
Country A
5
10
Country B
8
4
Specialization based on relative factorendowment
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The ratios are the same as before: in the relatively capitalabundant country capital is relatively cheap compared with
wages, while in the labor-abundant country this relationship
is reversed.
Now we introduce the two products that these two
countries can produce: the first will be computers (c), the
second: textiles (t). We assume that producing computers
requires more capital than labor (it is capital-intensive),
while producing clothes requires more labor than capital (it
is labor-intensive).
The Production Possibility Frontier
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Here we can see the poduction possibility frontiers of country A
and B. These represent the computer-textile combinations
which are available for them using all of their production factors:
t
Country A
Country B
c
The Production Possibility Frontier
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On the previous figure we could also notice
that country A has absolute advantage both in
producing computers and textiles.
However, country A is relatively better in
producing computers, while country B in
producing textiles.
Country A has comparative advantage in
producing computers, while country B in
producing textiles.
Trade between Countries
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Now we allow the countries to exchange
goods, but not production factors.
The exchange rate must be between the price
ratios of the two countries.
For the sake of simplicity let’s suppose that
the exchange rate is 1: 1.
Specialization
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The countries can improve further their utility by
specialization. The direction of specialization will be
determined by comparative advantages.
The relatively capital-abundant country A will specialize in
producing computers, while the relatively labor-abundant
country B will specialize in producing textiles.
According to this the relatively capital-abundant country
will specialize in producing capital-intensive, while the
relatively labor-abundant-country in labor-intensive
goods. This is the so called Heckscher-Ohlin-Theorem.
Specialization
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During specialization the relative prices of goods are
changing. The more computers are being made in country A, the
higher will be the computers/textiles price ratio.
The same process (in the opposite direction) takes place in
country B, so here the price of textiles increase compared with
that of the computers.
In the end, the relative prices of goods will be equalized.
Hechscher-Ohlin-Samuelson Theorem
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Together with the relative price changes of goods, the
relative use of the factors of productions is also
changing.
This leads to a change of relative prices in the factor
market.
As country A uses more capital, the relative price of it
increases, while in country B an opposite process takes
place.
In the end, together with the levelling of relative prices of
goods, a same process occurs in the market of factors of
production, because the price is determined by the cost,
i.e. by the prices of capital and labor.
Hechscher-Ohlin-Samuelson Theorem
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As a consequence of specialization and trade,
both relative prices of goods, and those of the
factors are levelling.
This result has been first shown by Paul Samuelson,
Nobel-laureate in economics, and has been named
after him Heckscher-Ohlin-Samuelson-Theorem.
The main point is that by allowing trade and
specialization, but not factor mobility, relative prices of
production factors do equalize.
Hechscher-Ohlin-Samuelson Theorem
In reality, this levelling of interest rates and wages is not
taking place. Why?
Model-conditions: 1. Both countries produce both
products; 2. same technology of production; 3.
prices are levelled by trade.
But:
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2.
3.
Not every products are produced by everyone.
Different technology of production.
No total convergence in prises.
The Leontief paradox
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In the early 50s Wasily Leontief, an
American economist, empirically tested the
Heckscher-Ohlin-Theorem.
He found that the result didn’t support the
theory. In fact, it was contradictory of it: the
export of the USA (a relatively capitalabundant country) was more labor-intensive
(less capital intensive) than the import of the
country. This result is the so called Leontief
paradox.
The Leontief paradox
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There are numerous explanations dealing with
this situation.
The most plausible of them is that there are
differences between labor and labor. While
American exports consist of mainly high skilled
labor, imports mainly low skilled.
According to this reasoning, the theory lacks the
empirical power because of simplification of
labor. This result already emphasized the
importance of human capital 50 years ago.
Trade in the Heckscher-Ohlin Model Conclusion
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An economy will be relatively efficient at
(have a comparative advantage in) producing
goods that are intensive in its abundant factors
of production.
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An economy will export goods that are
intensive in its abundant factors of production
and import goods that are intensive in its
scarce factors of production.
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This proposition is called the Heckscher-Ohlin
theorem
Trade in the Heckscher-Ohlin Model Conclusion
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Because an economy can afford to consume more
with trade, the country as a whole is made better off.
But some do not gain from trade, unless the model
accounts for a redistribution of income.
Trade changes relative prices of goods, which have
effects on the relative earnings of labor and capital.
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A rise in the price of cloth raises the purchasing power of
domestic laborers, but lowers the purchasing power of
domestic capital owners.
The model predicts that with trade owners of
abundant factors gain, but owners of scarce
factors lose.