1. Economics and Development International trade, Lecture 12
Giorgia Giovannetti
Professor of Economics, University of Firenze 1

2. Today Programme Mid term Dates for group presentations H-O
Leontief paradox

3. Plan of the course/lectures
International Trade, September 16th- December 8th 1 
16/9 
Introduction: The main issues 2 
 19/9
Introduction, 2 detailed presentation of the course 3 
 23/9
Introduction, 3; Measuring globalization 4 
 26/9
Measuring Globalization, (VA) and overview of models  5
 30/9
Overview trade models (Bernard et al 2007; 2011)  6
 3/10
Gravity model  7
 7/10
Gravity, Melitz intro  8
 10/10
Melitz  9
 14/10
Trade models: Ricardo
 10
 17/10
Trade models: Ricardo and H-O
 11
 21/10
Trade models: H-O,2, Leontieff
 12
 24/10
H-O, end, Trade and Imperfect competition, 1
 13
 28/10
Trade and imperfect competition, end
 14
 31/10
Mid term (indicators, gravity, Ricardo, H-O, imp. Comp)
 15
 4/11
Hysteresis, Heterogeneous firms
 16
 7/11
The Melitz model
 17
 11/11
Networks of tradeFDI/migrants
 18
 14/11
FDI and Multinationals: OLI theory
 19
 18/11
FDI and Multinationals Offshoring/trade in tasks
 20
 21/11
Trade policy
 21
 25/11
Trade policy- trade wars
 22
 28/11
China and India (BRICS)
 23
 2/12
Granularity and aggregate shocks
 24
 5/12
Final test
Plan of the
course/lectures

4. Proposal of change International Trade, September 16th- December 8th 1 1 
16/9 
Introduction: The main issues 2 
 19/9
Introduction, 2 detailed presentation of the course 3 
 23/9
Introduction, 3; Measuring globalization 4 
 26/9
Measuring Globalization, (VA) and overview of models  5
 30/9
Overview trade models (Bernard et al 2007; 2011)  6
 3/10
Gravity model  7
 7/10
Gravity, Melitz intro  8
 10/10
Melitz  9
 14/10
Trade models: Ricardo
 10
 17/10
Trade models: Ricardo and H-O
 11
 21/10
Trade models: H-O,2, Leontieff
 12
 24/10
H-O, end, Trade and Imperfect competition, 1
 13
 28/10
Trade and imperfect competition, end
 14
 31/10
Mid term Hysteresis, Heterogeneous firms
 15
 4/11
Brexit UK, G, I , F1
Hysteresis, Heterogeneous firms
 16
 7/11
Brexit F2, S, S2, P 
The Melitz model
 17
 11/11
Networks of tradeFDI/migrants/ MIDTERM
 18
 14/11
INAUGURAL LECTURE/OTTAVIANO
 19
 18/11
GVC 1-3
FDI and Multinationals Offshoring/trade in tasks
 20
 21/11
Trade and w. 2 Prod 2 
Trade policy
 21
 25/11
Trade policy- trade wars/ FDI and Multinationals: OLI theory
 22
 28/11
China and India/ new th. FDI Offshoring/trade in tasks,
 23
 2/12
New new theory 
Granularity and aggregate shocks
 24
 5/12
Final test
Proposal of change

5. Brexit UK
Sophie Geyerhofer (Austria/Bachelor) and Mirko Möllnitz (Germany/Master), Radka Stofanakova (Slovakia/Bachelor), Fiona Canjels(Netherlands/Bachelor)
4 Erasmus
4/11
Germany
Nina Kunzmann , Victoria Pörings, Caro Preuß
Italy
Jose Carlos Cuenca Serrano, David Lopez Laguardia, María Jimenez Nieto and Mara van Nuland Azuaga.
France 1
Fien Yskout, L, Scheldewaert, J. Puelings, M. Dobblelaere
Spain
Andrea Simón Díaz, Beatriz Ramón Cienfuegos-Jovellanos, Laura Porto Vergara y Catalina Manea Surubaru.
7/11
Spain 2/cat
J. Rujas, I. Romero, Pedro
Ireland
Frederique Bosveld, Anastasia Weiz, Gina Kuhlmann and Isabelle Schrage
Poland
Anna Tereshchenko ( Erasmus, Master degree), Viktoriia Kovryha (  Erasmus, Master degree)
GVCs 1
Kevin Mahekpreet Cheema, Moritz Pfeffer, Sebastian Munoz and Keno-Leon Hartman
18/11
GVC 2
Szczepan Czernatowicz, MSC, Franziska Fasel, MSC, Alea Burkard, BSC,Anna Gschwind, BSC
GVC 3
Leonardo Rosini, Michele Fontani e Sharon di Cocco
3 DEV
Productivity
Jan Hauer 2. Clara Barroso Raya, 3. Victor Martin Ortega, 4. Juan Alberto Alonso Perez
21/11
Mara Chlechowitz; Alfredo Conde
Trade and wages
Salazar E. Vania, Mejia, Isaza V., Maach Fatima Zohra S
Carlo Poggi, -Iacopo Maria Taddei  ,Andrea Cioli
New Trade Theory
C.Moretti
ECO
2/12

6. Presentations Brexit Every presentation 20 minutes Data:
ITC, Export potential map,
Cepii, ?id=30
«The Atlas of Economic Complexity» di Harvard:
atlas.cid.harvard.edu
globe.cid.harvard.edu
«Global Economic Dynamics» di Bertelsmann- Stiftung:
viz.ged-project.de

7. References on Brexit
The latest on Brexit from the Decision Maker Panel, Nicholas Bloom, Philip Bunn, Scarlet Chen, Paul Mizen, Pawel Smietanka 25 September 2019, voxeu
The impact of Brexit on UK firms, Nicholas Bloom, Philip Bunn, Scarlet Chen, Paul Mizen, Pawel Smietanka, Gregory Thwaites 04 September
EU-UK global value chain trade and the indirect costs of Brexit, Rita Cappariello, Michele Mancini, Filippo Vergara Caffarelli 22 March
Quantifying Brexit: From Ex Post to Ex Ante Using Structural Gravity, Felbermayr, Gabriel / Gröschl, Jasmin Katrin / Steininger, Marina, CESifo, Munich, 2018, Working Paper No
Economic Effects of Brexit on the European Economy, Felbermayr, Gabriel / Fuest, Clemens / Gröschl, Jasmin Katrin / Stöhlker, Daniel, ifo Institute, Munich, 2017, EconPol Policy Report 4,

8. References on Brexit
The Impact of Brexit on German Businesses Results of the IHK Business Survey Going International 2019
Brexit: The Consequences for Other EU Member States, by Oliver Patel and Alan Renwick,
IRELAND & THE IMPACTS OF BREXIT,
Blogs of various type

9. References on Brexit http://personal.lse.ac.uk/sampsont/papers.html
IMF country Report, The Long-Term Impact of Brexit on the European Union, August 2018
Should we fear the Brexit uncertainty? IMF versus Krugman COMPETITIVENESS & GROWTH EUROPE, Post, August 19, 2016, Par Stéphane Lhuissier, Fabien Tripier, CEPII
Review of EU-third country cooperation on policies falling within the ITRE domain in relation to Brexit,  J. SCOTT MARCUS, GEORGIOS PETROPOULOS, ANDRÉ SAPIR, SIMONE TAGLIAPIETRA, ALESSIO TERZI, REINHILDE VEUGELERS AND GEORG ZACHMANN, 2017
IMF, uk country report, November 2018
Mikolajun, Irena / Viaene, Jean-Marie: Is Hard Brexit Detrimental to EU Integration? Theory and Evidence CESifo Working Paper No. 7199, August 2018
Europe after Brexit: A proposal for a continental partnership by Jean Pisani-Ferry, Norbert Röttgen, André Sapir, Paul Tucker, Guntram B. Wolff, 25 August 2016, Bruegel

10. References on
The Age of Global Value Chains:
Maps and Policy Issues, Edited by João Amador and Filippo di Mauro, CEPR Press, 2015 (a couple of chapters) ;
Cattaneo, O., G. Gerrefi, S. Miroudot, and D. Taglioni (2013). “Joining, Upgrading and Being Competitive in Global Value Chains: A Strategic Framework.” World Bank Policy Research Paper No
D. Wrinkler and D. Taglioni:
Globalization in transition: the future of trade and Value Chains, Mc Kinsey, January 2019
Sturgeon, T. and M. Kawakami (2010), “Global Value Chains in the Electronics Industry: Was the Crisis a Window of Opportunity for Developing Countries?”, in Cattaneo, O., G. Gereffi and C. Staritz (eds.), Global Value Chains in a Postcrisis World, A Development Perspective, Washington, DC: The World Bank, 2010, pp
Baldwin, R., & Lopez-Gonzalez, J. (2014). Supply-chain Trade: A Portrait of Global Patterns and Several Testable Hypotheses. The World Economy, (October 2012).

11. References on: Trade and wages
Recent Vox survey:
Lawrence:
Krugman:
Feenstra:
MITCHENER AND SE YAN, GLOBALIZATION, TRADE, AND WAGES: WHAT DOES HISTORYTELL US ABOUT CHINA? INTERNATIONAL ECONOMIC REVIEW, Vol. 55, No. 1, February 2014

12. References on: New New Trade Theory
The importance of firms’ heterogeneity. The Melitz (2003) model
Marc J. Melitz and Daniel Trefler Gains from Trade when Firms Matter Journal of Economic Perspectives—Volume 26, Number 2—Spring 2012—Pages 91–118
Bernard, Andrew B., J. Bradford Jensen, Stephen J. Redding, and Peter K. Schott (2007), “Firms in International Trade”, Journal of Economic Perspectives, 21(3): 105–130.
Bernard, A.B., Jensen, J.B., (1995), “Exporters, jobs and wages in U.S. manufacturing, ”, Brookings Papers on Economic Activity: Microeconomics, pp
Breaking down the barriers to firm growth in Europe: the fourth EFIGE policy report by Loris Rubini, Klaus Desmet, Facundo Piguillem and Aránzazu Crespo, Bruegel, 2012
M. Melitz, M. (2003),“The impact of trade on intraindustry reallocations and aggregate industry productivity”, Econometrica, vol. 71, pp

13. References Productivity
REMAKING EUROPE: THE NEW MANUFACTURING AS AN ENGINE FOR GROWTH, Reinhilde Veugelers, editor, BLUEPRINT SERIES 26, 2017 (need to select some chapters, can be object of different resentations)
European Productivity, Innovation and Competitiveness: The Case of Italy , Prepared by Andrew Tiffin, IMF WP, May 2014
Breaking down the barriers to firm growth in Europe: the fourth EFIGE policy report by Loris Rubini, Klaus Desmet, Facundo Piguillem and Aránzazu Crespo, Bruegel, 2012
EUROPE’S TRUST DEFICIT CAUSES AND REMEDIES Christian Dustmann et al, August 2017, CEPR books
From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy Christian , Bernd Fitzenberger , Uta Schönberg , Alexandra Spitz-Oener, Journal of Economic Perspectives, 2014, Pages 167–188
Marin et al, 2015 Europe’s exports superstar – it’s the organisation!, Bruegel WP

14. Summary last lecture We introduced the H-O model
H-O theory emerged in Sweden.
Eli Heckscher (an economic historian) developed the core idea in a brief article in 1919.
A clear overall explanation was developed and publicized in the 1930s by Heckscher’s student Bertil Ohlin (a professor and politician, a Nobel laureate).
Ohlin’s arguments were later reinforced by Paul Samuelson (another Nobel laureate), who derived mathematical conditions under which the H-O prediction was strictly correct.

15. H-O
The H-O theory emphasizes the role of relative differences in resource endowments as the ultimate determinant of comparative advantage. The H-O theory explains comparative advantage in terms of underlying
differences across countries in the availability of factor resources (factor endowment) – abundant vs scarce factors;
differences across products in the use of these factors in producing the products – labor-intensive, capital-intensive, land-intensive, etc.

16. Factor abundance
different factor endowments refers to different relative factor endowments, not different absolute endowments.
In other words, different factor endowments = different factor proportions.

17. Relative factor abundance
May be defined in two ways:
physical definition (in terms of the physical units of two factors). For example, (K/L)I > (K/L)II  Country I is capital-abundant;
price definition (in terms of the relative prices. The greater the relative abundance of a factor, the lower its relative price). For example, (r/w)I < (r/w)II  Country I is capital-abundant.

18. Commodity factor intensity
A commodity is said to be factor-X-intensive whenever the ratio of factor X to a second factor Y is larger when compared with a similar ratio of factor usage of a second commodity.
Consider labor:
A country is relatively labor-abundant if it has a higher ratio of labor to other factors than does the rest of the world.
A product is relatively labor-intensive if labor costs are a greater share of its value than they are of the value of other products.

19. How does the relative abundance of a resource determine comparative advantage?
When a resource is relatively abundant, its relative cost is less than in countries where it is relatively scarce.
Difference in relative resource costs causes the pre-trade differences in relative product prices between two countries.

20. H-O in their words… The H-O theory says, in Ohlin’s own words:
Commodities requiring for their production much of [abundant factors of production] and little of [scarce factors] are exported in exchange for goods that call for factors in the opposite proportions. Thus indirectly, factors in abundant supply are exported and factors in scanty supply are imported.
(Ohlin, Bertil. International and Interregional Trade, MA: Harvard University Press, 1933)

21. H-O Summary The Heckscher-Ohlin (H-O) Model Assumptions
Homogeneous goods and factors
Perfectly competitive market equilibrium throughout (goods and factors)
Production functions
Constant returns to scale
Non-joint
Factors
Perfectly mobile across industries
Perfectly immobile across countries
Countries differ in factor endowments
Industries differ in factor intensities

22. H-O Model Two goods (different intensities), two factors;
Both factors can move freely between the industries.
Shoe production is labor-intensive—it requires more labor per unit of capital to produce shoes than computers.
Foreign is labor abundant; the labor-capital ratio in Foreign exceeds that in Home. Equivalently, Home is capital abundant.
The final outputs can be traded freely between nations, but labor and capital do not move between countries.
The technologies used to produce the two goods are identical across the countries.
Consumer tastes are the same across countries, and preferences for computers and shoes do not vary with a country’s level of income.

23. First we determined equilibrium in autharky

24. The Textbook 2×2 H-O Model, summary
Goods X, Y
Factors K, L
X is K-intensive
Goods are final goods
Trade is
Free and frictionless, or
Subject to simple, constant trade costs per unit (perhaps “iceberg”)

25. Summary Heckscher-Ohlin Model
No-Trade Equilibrium
Production Possibilities Frontiers, Indifference Curves, and No-Trade Equilibrium Price
FIGURE 4-2 (1 of 3)
No-Trade Equilibria in Home and Foreign
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.

26. Summary Heckscher-Ohlin Model
No-Trade Equilibrium
Production Possibilities Frontiers, Indifference Curves, and No-Trade Equilibrium Price
FIGURE 4-2 (2 of 3)
No-Trade Equilibria in Home and Foreign (continued)
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.

27. Summary Heckscher-Ohlin Model
No-Trade Equilibrium
Production Possibilities Frontiers, Indifference Curves, and No-Trade Equilibrium Price
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*.

28. Then we opened up to trade ….

29. Summary: Heckscher-Ohlin Model
Free-Trade Equilibrium
Home Equilibrium with Free Trade
FIGURE 4-3 (1 of 2)
International Free-Trade Equilibrium at Home
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).

30. Summary: Heckscher-Ohlin Model
Free-Trade Equilibrium
Home Equilibrium with Free Trade
FIGURE 4-3 (2 of 2)
International Free-Trade Equilibrium at Home (continued)
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).
In panel (b), we show Home exports of computers equal to zero at the no-trade relative price, (PC /PS)A,
and equal to (QC2 − QC3) at the free-trade relative price, (PC/PS)W.

31. Summary Heckscher-Ohlin Model
Free-Trade Equilibrium
Foreign Equilibrium with Free Trade
FIGURE 4-4 (1 of 2)
International Free-Trade Equilibrium in Foreign
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).

32. Summary Heckscher-Ohlin Model
Free-Trade Equilibrium
Foreign Equilibrium with Free Trade
FIGURE 4-4 (2 of 2)
International Free-Trade Equilibrium in Foreign (continued)
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).
In panel (b), we show Foreign imports of computers equal to zero at the no-trade relative price, (P*C /P*S)A*, and equal to (Q*C3 − Q*C2) at the free-trade relative price, (PC /PS)W.

33. Summary: Heckscher-Ohlin Model
Free-Trade Equilibrium
Equilibrium Price with Free Trade Because exports equal imports, there is no reason for the relative price to change and so this is a free-trade equilibrium.
FIGURE 4-5
Determination of the Free-Trade World Equilibrium Price
The world relative price of computers in the free-trade equilibrium is determined at the intersection of the Home export supply and Foreign import demand, at point D.
At this relative price, the quantity of computers that Home wants to export, (QC2 − QC3), just equals the quantity of computers that Foreign wants to import, (Q*C3 − Q*C2).

34. Summary: Heckscher-Ohlin Model
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.

35. More in detail: Heckscher-Ohlin
Since the two nations have equal tastes, they face the same indifference map.
Indifference curve I is the highest IC that Nation 1 and Nation 2 can reach in isolation, and points A and A/ represent their equil. points of production and consumption in the absence of trade.
The tangency of IC I at points A and A/ defines the no-trade equil-relative commodity prices of PA in Nation 1 and PA/ in Nation 2.
Since PA < PA/ , Nation 1 has a com-adv. in X and Nation 2 has a com-adv. in Y.

36. The Heckscher-Ohlin Model.

37. The right panel shows that with trade Nation 1 specializes in X and Nation 2 in Y.
Specialization continues until Nation 1 reaches point B and Nation 2 B/, where the transformation curves are tangent to the common relative price line PB.
Nation 1 exports X in exchange for Y and consume at point E on IC II. Nation 2 exports Y for X and consume at point E/ (which coincides with point E).
Note that Nation 1’s exports of X equal Nation 2’s imports of X (i.e. BC=C / E /).
Similarly, Nation 2’s exports of Y equal Nation 1’s imports of Y (i.e. B / C / =C E).

38. At PX/PY > PB, Nation 1 want to export more of X than Nation 2 wants to import at this high relative price, and PX/PY falls towards PB.
At PX/PY < PB, Nation 1 want to export less of X than Nation 2 wants to import at this low relative price, and PX/PY rises towards PB.
Point E involves more of Y but less of X than point A
However, Nation 1 gains from trade because E is on higher IC II.
Similarly, at E/ which involves more X but less Y than A/, Nation 2 is better of because E/ is on higher IC II.

39. Heckscher-Ohlin Model
When a country opens to trade:
The relative price of computers in Home rises from the no-trade price.
This gives Home an incentive to produce more computers and export the difference.
The relative price of computers in Foreign falls from the no-trade price.
This gives Foreign an incentive to produce fewer computers and import the difference.
This also means the relative price of shoes in Foreign arises giving Foreign the incentive to increase production and export the difference

40. H-O Summary The Heckscher-Ohlin (H-O) Model Implications
Countries export goods that use intensively their abundant factors (H-O Theorem)
Trade draws factor prices closer together across countries, becoming equal in certain circumstances (FPE Theorem)
Trade changes real factor prices (S-S Theorem)
Benefiting owners of abundant factors
Hurting owners of scarce factors
Rybczynski Thm (output effects of factor accumulation)

41. More on the Stolper-Samuelson Theorem
Derived from the HO model
Assumptions:
Labor earns wages proportionate to its skill level
Owners of capital earn profits
Landowners earn rents
The amount of income earned per unit of input depends on both the demand for inputs and the supply of inputs (demand for an input = derived demand)

42. The Stolper-Samuelson Theorem
An increase in the demand for a good (opening International Trade?) … increases the price of a good…. and raises the income earned by factors that are used intensively in its production
Conversely, decrease in the demand for a good … decreases the price of a good…. and reduces the income earned by factors that are used intensively in its production

43. Stolper-Samuelson Theorem
When PC/PF ↑, w/r ↑.
So, L/K ↓ in both industries
So, productivity of capital ↓ in both industries, and
productivity of labor ↑ in both industries.
So, w/PC and w/PF both ↑, whereas
r/PC and r/PF both ↓.
When PC/PF ↓, w/r ↓.
So, L/K ↑ in both industries
So, productivity of capital ↑ in both industries, and
productivity of labor ↓ in both industries.
So, w/PC and w/PF both ↓, whereas
r/PC and r/PF both ↑.
HOME labor abundant
FOREIGN capital abundant

44. The Stolper-Samuelson Theorem
Example … increase production of steel … increase need for K ...

45. The Stolper-Samuelson Theorem
Note:
Not all factors used in the export industries will be better off, and not all factors used in import competing industries get hurt: Abundant factors will benefit, while scarce ones will be hurt

46. The Stolper-Samuelson Theorem
Ultimately, the effects on income of an opening of trade depends on the flexibility of the affected factors
If labor is stuck in bread production and unable to move to making steel, it will be hurt much worse than when it is flexible and free to move
U.S. avocado producers might not oppose Mexican avocado imports as fiercely as they do, if they could easily move to producing other goods

47. Implications of Stolper-Samuelson Theorem
Some groups in society will oppose international trade.
Scarce factors will lobby government for trade protection.
Even though some in society lose, the country overall benefits from international trade relative to autarky.
A system of taxation and transfers could be developed to compensate the losers while leaving the gainers better off relative to autarky.

48. Resources and Output
How do levels of output change when the economy’s resources change?
Rybczynski theorem: If you hold output prices constant as the amount of a factor of production increases, then the supply of the good that uses this factor intensively increases and the supply of the other good decreases.

49. Resources and Output
Assume an economy’s labor force grows, which implies that its ratio of labor to capital L/K increases.
Expansion of production possibilities is biased toward cloth.
At a given relative price of cloth, the ratio of labor to capital used in both sectors remains constant.
To employ the additional workers, the economy expands production of the relatively labor-intensive good cloth and contracts production of the relatively capital-intensive good food.

50. Resources and Output
An economy with a high ratio of labor to capital produces a high output of cloth relative to food.
Assumption: Home is relatively abundant in labor and Foreign is relatively abundant in capital:
L/K > L*/ K*
Likewise, Home is relatively scarce in capital and Foreign in labor.
Home will be relatively efficient at producing cloth because cloth is relatively labor intensive.

51. Relative Supply Curves
RS*
Assumption: Home is relatively abundant in labor and Foreign is relatively abundant in capital RS

52. Fig. 5-9: Trade Leads to a Convergence of Relative Prices
3: Autarky Foreign
2: Free Trade
1: Autarky: Home

53. Factor Price Equalization
Unlike the Ricardian model, the Heckscher-Ohlin model predicts that factor prices will be equalized among countries that trade.
Free trade equalizes relative output prices.
Due to the connection between output prices and factor prices, factor prices are also equalized.
Trade increases the demand of goods produced by relatively abundant factors, indirectly increasing the demand of these factors, raising the prices of the relatively abundant factors.

54. Factor Price Equalization (cont.)
In the real world, factor prices are not equal across countries.
The model assumes that trading countries produce the same goods, but countries may produce different goods if their factor ratios radically differ.
The model also assumes that trading countries have the same technology, but different technologies could affect the productivities of factors and therefore the wages/rates paid to these factors.

55. Table 5-1: Comparative International Wage Rates (United States = 100)

56. Factor Price Equalization (cont.)
The model also ignores trade barriers and transportation costs, which may prevent output prices and thus factor prices from equalizing.
The model predicts outcomes for the long run, but after an economy liberalizes trade, factors of production may not quickly move to the industries that intensively use abundant factors.
In the short run, the productivity of factors will be determined by their use in their current industry, so that their wage/rental rate may vary across countries.

57. Does Trade Increase Income Inequality?
Over the last 40 years, countries like South Korea, Mexico, and China have exported to the U.S. goods intensive in unskilled labor (ex., clothing, shoes, toys, assembled goods).
At the same time, income inequality has increased in the U.S., as wages of unskilled workers have grown slowly compared to those of skilled workers.
Did the former trend cause the latter trend?

58. Does Trade Increase Income Inequality? (cont.)
The Heckscher-Ohlin model predicts that owners of relatively abundant factors will gain from trade and owners of relatively scarce factors will lose from trade.
Little evidence supporting this prediction exists.
According to the model, a change in the distribution of income occurs through changes in output prices, but there is no evidence of a change in the prices of skill-intensive goods relative to prices of unskilled-intensive goods.

59. Does Trade Increase Income Inequality? (cont.)
According to the model, wages of unskilled workers should increase in unskilled labor abundant countries relative to wages of skilled labor, but in some cases the reverse has occurred:
Wages of skilled labor have increased more rapidly in Mexico than wages of unskilled labor.
But compared to the U.S. and Canada, Mexico is supposed to be abundant in unskilled workers.
Even if the model were exactly correct, trade is a small fraction of the U.S. economy, so its effects on U.S. prices and wages prices should be small.

60. Trade and Income Distribution
Changes in income distribution occur with every economic change, not only international trade.
Changes in technology, changes in consumer preferences, exhaustion of resources and discovery of new ones all affect income distribution.
Economists put most of the blame on technological change and the resulting premium paid on education as the major cause of increasing income inequality in the US.
It would be better to compensate the losers from trade (or any economic change) than prohibit trade.
The economy as a whole does benefit from trade.

61. Trade and Income Distribution (cont.)
There is a political bias in trade politics: potential losers from trade are better politically organized than the winners from trade.
Losses are usually concentrated among a few, but gains are usually dispersed among many.
Each of you pays about $8/year to restrict imports of sugar, and the total cost of this policy is about $2 billion/year.
The benefits of this program total about $1 billion, but this amount goes to relatively few sugar producers.

62. Strong … Assumptions Perfect competition Constant returns to scale
No factor mobility
Two countries must be identical and trade must be balanced

63. Test of the Heckscher-Ohlin Model
The Test:
W. Leontief (1951)
Could “H-O … Factor Proportions Theory” be used to explain the types of goods the United States imported and exported?
The Method:
Built input-output model for 200 U.S. industries for 1947

64. Testing the H-O Theorem: Leontief’s Paradox
Wassily Leontief performed the first test of the HO theorem in 1953 using data for the U.S. from 1947.
He measured the amounts of labor and capital used in all industries needed to produce $1 million of U.S. imports and to produce $1 million of imports into the U.S.
This data also shows the capital/labor ratio in dollars per person.

65. Leontief Leontief’s Test
Table 4.1 Leontief’s Test Leontief used the numbers in this table to test the Heckscher-Ohlin theorem. Each column shows the amount of capital or labor needed to produce $1 million worth of exports from, or imports into, the United States in 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.
Source: Wassily Leontief, 1953, “Domestic Production and Foreign Trade: The American Capital Position Re-examined,” Proceedings of the American Philosophical Society, 97, September, 332–349. Reprinted in Richard Caves and Harry G. Johnson, eds., 1968, Readings in International Economics, Homewood, IL: Irwin.

66. Leontief
Leontief used labor and capital used directly in the production of final good exports in each industry.
He also measured the labor and capital used indirectly in the industries that produced the intermediate inputs used in making exports.
The capital is high because we are measuring the whole capital stock—not the part actually used to produce exports.
The capital/labor ratio was $14,000: each person employed was working with $14,000 worth of capital.
It was impossible for Leontief to get information on the amount of labor and capital used to produce imports.
He used data on U.S. technology to estimate amounts of labor and capital used in imports from abroad. (Remember the HO model assume technologies are the same across countries.)
This gave a capital/labor ratio of $18,200 per worker.
This exceeds the ratio for exports.

67. Leontief
Leontief assumed correctly that in 1947 the U.S. was capital abundant relative to the rest of the world.
From the HO model, Leontief expected that the U.S. would export capital intensive goods and import labor intensive goods.
Leontief, however, found the opposite.
The capital labor ratio for U.S. imports was higher than for exports.
This contradiction came to be called Leontief’s paradox.

68. EMPIRICAL EVIDENCE ON THE H-O FACTOR-PROPORTIONS THEORY
The Findings:
The Leontief Paradox
Leontief found that U.S. exports were less capital-intensive than U.S. imports, even though U.S. is the most capital-abundant country in the world

69. The Leontief Paradox The Controversy:
Findings were the opposite of what was generally believed to be true!

70. Reconciliations of the Leontief Paradox
U.S. workers are more productive than foreign workers (Leontief) and Human Skills Theory (1966)
A third factor, natural resources, is not considered (Vanek)
U.S. tariffs on labor-intensive goods are high (Travis)
The identical tastes assumption is violated; Table (next page) shows that consumption patterns differ across countries

71. The Leontief Paradox Why would this paradox exist?
U.S. and foreign technologies are not the same as assumed.
By focusing only on labor and capital, land abundance in the U.S. was ignored.
No distinction between skilled and unskilled labor.
The data for 1947 could be unusual due to the recent end of WWII.
The U.S. was not engaged in completely free trade as is assumed by the HO model.

72. Leontief Paradox, 2
Several of the explanations depend on having more than two factors of production.
The U.S. is land abundant, and much of what it was exporting might have been agricultural products which use land intensively.
It might also be true that many of the exports used skilled labor intensively.
More current research was aimed at redoing the Leontief test.
The “extended” HO model works much better for the same year of data.

73. Consumption Shares by Product Type for OECD Countries Average Values 1985–1999*

74. Human Skills Theory Donald Keesing (1966)
Emphasizes differences in endowments and intensities of skilled and unskilled workers.
Explains the Leontief paradox: Since the U.S. has highly trained, educated workers relative to other countries, U.S. exports tend to be skilled-labor intensive.

75. Summary Testing the Heckscher-Ohlin Model
Differing Productivities across Countries
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

76. Criticism
We may not see the clear-cut income distribution effects with trade because relative factor prices in the real world do not often appear to be as responsive to trade as the H-O and S-S imply.
In addition, income distribution reflects not only the distribution of income between factors of production but also the ownership of the factors of production. Since individuals or households often own several factors of production, the final impact of trade on personal income distribution is far from clear.