International Economics

Lecture 5

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 Heckscher-Ohlin

Hechscher-Ohlin proposition

In a neoclassical 2x2x2 world, with homothetic preferences, a

country will export the good which intensively uses the relatively
abundant factor of production.

• A country abundant in K, exports manufactures

• A country abundant in L, exports food

• NOTE: in the neoclassical model, the direction of trade ows

stems from the supply structure

• However, must take into account demand structure to

understand fully the directions of trade
• Exports=Production-Consumption

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 Demand
• ASSUMPTION: all countries have identical tastes.
• δm C1−δm ; 0 < δ < 1,s.t I = P C + p C
Consumers max U = Cm f m m m f f
• Homothetic preferences: iso-utility curves similar to isoquants for CRS

• Where MRS = ∂U/∂Cm

∂U/∂C f = pm
pf

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Contries with dierent tastes

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PPF construction
from the Edgeworth box

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 Production possibilities frontier
Increasing Opportunity Costs
• In order to produce additional units of a good, a nation must give up
more and more of the other good;
• opportunity cost is also the
• MARGINAL RATE OF TRASFORMATION (MRT): absolute value
of the slope of PPF
• PPF is concave to the origin;

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PPF for two nations with dierent endowments of inputs

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 PPF 2
and capital intensity

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 Rybcynski lines
• consider how changes in availability of K, L aects changes in M, F, i.e.
M̃max = αm K̃ + (1 − αm )L̃; F̃max = α f K̃ + (1 − α f )L̃, where
M̃, F̃,K̃, L̃ = dM,dF,dK,dL
M,F,K,L
• since αm > α f , if K increases, production of M increases more than
production of H: M̃ > F̃ .

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 Structure of equilibrium

Six conditions for equilibrium:

1) consumers max U , 2) producers max Π, 3) all labourers employed, 4) all capital is used, 5) supply =
demand for manufactures, 6) supply = demand for food

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 Autarky equilibrium
K = L = 5, αm = 0.8, α f = 0.2, δm = 0.6

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 Autarky equilibrium and capital intensity
K = L = 5, αm = 0.9, α f = 0.2, δm = 0.8
with αm = 0.9 > 0.8, the PPF is more curved and a higher share of income is
spent on manufactures: δm = 0.8 > 0.6

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Autarky in Austria and Bolivia

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 Equilibrium with exchange
an international price is formed between domestic prices (opportunity costs)

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 International trade equilibrium
Austria
pm Bolivia
      
pm pm pm
< < & MRTtrade = = MRStrade
pf autarky
p f trade p f autarky p f trade

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International trade and the Rybcynski Lines

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 Incomplete specialisation
• In Ricardo, under constant opportunity costs and a straight
line PPF,
Since it paid for country A and country B to have some of the
comparative disadvantage good, it paid also to have all of that
good from the other nation
⇒COMPLETE SPECIALISATION
• Now, under increasing opportunity costs, there is
INCOMPLETE SPECIALISATION
• A and B specialise, but continue to produce some of the other
good;
• When nation A (or B) specialises in good X (or Y), it faces
increasing costs in the production of X (or Y) and declining
costs in the production Y (or X)
• As a nation specialises, relative commodity prices dierences
are reduced to the point that they become identical

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 Small Country case

• INCOMPLETE SPECIALISATION occurred also in the

constant opportunity cost case, when one of the two countries
is small (remember Argentina and USA in the production on
m'chips and meat).

• In that case, while the small country fully specialised, the large
country needed to produce also the other good (USA
produced meat), because the small country could not sastisfy
all its import needs.

• Note that in this model, WITH INCREASING COSTS, even

the small nation does not fully specialise

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Gains from Exchange vs Gains from Specialisation

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Identical endowments of inputs, but dierences in tastes
When tastes are dierent, under increasing cost, even if the two
countries had identical PPF, there would be a basis for mutually
benecial trade.

Figure: Trade and Tastes

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Technology Intensive Manufacturing Exporters

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Primary product exporters

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 Leontie paradox

• 1951, Leontie: rst test of the HO model

• looked for evidence that the USA, the most K-abundant nation,
exported K-intensive goods, and imported L-intensive goods
• built an input-output table of the US economy to calculate L
and K in a representative bundle of 1million$ of exports and
import substitutes for year 1947

o Import substitutes -> products produced, but also

imported , by the US (foreign production data were non
available).

• These were more K-intensive that actual imports, but should

have been less K-intensive than exports

• PARADOX: import substitutes were 30% more K-intensive than

exports (opposite than HO)

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 Leontie paradox
Explanations
• Leontie explanation: US was more L-productive => the L-intensive nation
(labour force had to me multiplied by 3)
• WRONG: US is also more K-productive, (also capital should be
multiplied by 3)
• Tastes: US tastes favour of K-intensive products ⇒ higher relative price of K-
intensive commodities
• WRONG:tastes are similar across countries. Houthakker (1957):
income elasticity of demand for dierent classes of goods very similar
• Too close to WWII: Leontie repeated in 1951 (completion of postwar
reconstruction) and found that US exports were only 6% more L-intensive
than import substitutes, so REDUCTION of paradox
• Only two factors (K,L): natural resources can be important. Production
needing natural resources also requires lot of K. US dependence on imports
of natural resources may explain large K-intensity of US import substitutes.
• US tari policy: most taris try to protect the L-intensive industries, reducing
the L-intensity of US import substitutes

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 Leontie paradox
Explanations
• Leontieonly considered physical capital,did not consider HUMA N
CAPITAL and KNOWLEDGE CAPITAL (R&D): adding these to physical
capital makes US exports more K-intensive and R&D-intensive
• Many subsequent studies nd support for the HO model
• Kravis(1956):wages in US export industries are higher than in US
import competing (reecting greater productivity and human capital )
• Keesing (1966): US exports more skill intensive than other industrial
countries, because of more highly trained labour force
• Kenen (1965): adding estimated human capital eliminates the paradox
• Baldwin (1971): excluding natural resources insucient to eliminate
the paradox, adding human capital yes. However, paradox remains for
other countries
• Leamer (1980,1984): in a multi-factor world, should compare
production and consumption: production more K-intensive than
consumption
• Bower, Leamer, Sveikauskas (1987): with more complete data (more
countries, more factors, more goods, better data):,HO supported only
half of the times
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 Leontie paradox
Share of US and World Trade in dierent types of goods (1998)

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Another Leontie paradox explanation: factor intensity
reversal (FIR)
• a commodity may be the L-intensive in the L-abundant nation and the K-
intensive in the K-abundant nation
• the greater the dierence in the elasticity of substitution of K and L in goods X
and Y, the more likely is FIR
• under FIR, Heckscher Ohlin and factor price equalisation (FPE)do not hold

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