Some Practical Questions

Is there such a thing called complete specialization?

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Some Practical Questions

Is the North-South volume of trade flow larger than that of the North-North flow?

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Some Practical Questions

Why do governments interfere in the free flow of goods if free international trade is welfare improving?

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Some Practical Questions

What is the sources of comparative advantage (the source of differences in opportunity cost)?

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The Hecksher-Ohlin (H-O) Theory of International

Trade

The Neo-Classical Explanation of Trade

History

Eli Heckscher (1919); 1949 ; Bertil Ohlin (1924; 1933)

The HO ……

Countries no longer differ in the level of technology, but in the amount of factors with which they are endowed (Factor Endowment)

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The HO ..…

Compared to its trading partner, a country is either labor abundant or capital abundant.

Depends upon the relative capital labor ratios

i.e.,

The HO ..…

Goods differ in the amount of factors they require to be produced (i.e., in factor intensity)

Goods are either Capital or Labor intensive…

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The HO Theory

A country should produce (and thus export) good (s), the production of which, requires an intensive use of the factor which is relatively abundant in that country

The HO Theory

countries will have a comparative advantage in the production of good (s) which uses the country’s relatively abundant factor more intensively

i.e.,

The HO Theory

International Trade is based on resource availability ( Factor Abundance); Not technological difference

Example…

Suppose we are concerned with trade between:

U.S.A. MEXICO

Autos

Textiles

Example…Data

USA: 50 Machines (K) & 100 Workers (L)Mexico: 25 Machines (K) & 75 Workers (L)

Assume that Autos are K intensive and Textile is Labor intensive….

Question….

In which country should each product be produced?

Solution….

The HO theory says: K intensive goods should be produced in K abundant countries; andL intensive goods should be produced in L abundant countries

Question….

Determine…Which country is K abundant?Which country is L abundant?

Solution….

U.S.A. 50/100 =1/2 = 0.50

Mexico 25/75 =1/3 = 0.33

Note that …Autos are K

IntensiveTextile is L Intensive

Capital Labor Ratios (K/L)

Solution….

Autos are K Intensive

Textile is L Intensive

Is Capital (K) abundant

Is Labor (L) abundant

Autos ….

Textile …

Some Real World Data

1. Is the U.S.A. capital or labor abundant country?

2. Which industries are K intensive?

Capital Stock per Worker in Selected Countries-1990

Country Year-1990Germany 50,116

Sweden 39,409

Japan 36,480

USA 34,705

Mexico 12,900

.

.

Kenya 907

Nigeria 702

Capital Labor Ratios across US Industries

Industry K/L(1980)

K/L(2000)

Chemicals 58.9 85.9

Petroleum and Coal

161.2 266.7

Electrical Machines

13.0 35.3

Food Industries 22.5 36.8

Textiles 31.9 100.1

Source: Husted and Melvin, 2004

Why should a country produce the good which uses its relatively abundant factor?

Why would the USA has to produce Autos and Mexico textiles?

The Rationale behind HO…Differences in relative factor price ratios…

If country A ( say, the USA ) is K abundant, it must be that the ratio of the returns to capital (i.e., rents) to that of labor (i.e., wages)…is lower in that country than the other.

…because capital (K) is abundant and hence cheaper, whereas Labor (L) is scarce and hence expensive.

The Rationale behind HO…Differences in relative factor price ratios…

• Similarly, if country B ( say, Mexico) is Labor abundant, it must be that the ratio of Rents to Wages (R/W) is higher in Mexico than the U.S.A.

… because capital is scarce and hence expensive and labor is abundant and hence cheaper.

Implications….

The basis of trade (comparative advantage) is autarky relative factor price differentials, which gives rise to differences in opportunity cost

Implications….Implications….

Relative Factor Abundance

Comparative Advantage

Relative FactorPrice Difference

The HO and Classical Theory: Differences

Under HO, there is no complete specialization… …factors are imperfect substitutes, and firms face increasing opportunity cost of completely transferring resources fro one sector to the other.

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The HO and Classical Theory: Differences

Under HO, factor price equalization (resulting from adjustments in excess demand and supply), … not product price equalization

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The HO and Classical Theory: Differences

Under HO, there are restriction on demand…tastes and preferences are assumed to be identical, … not under classical

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