1) The document discusses various international trade models including absolute advantage, comparative advantage, and the Heckscher-Ohlin model. 2) It examines the Heckscher-Ohlin model in depth, outlining its key ideas including the Stolper-Samuelson theorem, Rybczynski theorem, and factor price equalization. 3) The Heckscher-Ohlin model predicts that countries will export goods that intensively use their abundant factors of production and import goods that intensively use their scarce factors.

1. INTERNATIONAL TRADE MODELS
& ASIAN ECONOMIC GROWTH
CHIRANTAN CHATTERJEE
1

2. Key Notions in International Trade
1) Absolute Advantage
2) Comparative Advantage
3) Terms of Trade
2

3. Some Basics in International Trade
1) David Hume’s Balance of Trade 1758
2) Puzzle for class:
Over the past few decades, East Asian economies have increased
their share of world GDP. Similarly, Intra-Asian trade has also
increased as a share of world-trade. Why?
3

4. Inspired by Physics & Newton
Newton’s Model
4

5. Some Basics in International Trade
1) Tinbergen’s (1962) Gravity Model
2) Economists show that 1% increase in distance between 2
countries -> fall in 0.7-1% trade.
3) So distance does matter – One of the most Robust Economic
Relationships
4) The argument behind RTAs
5

6. But Should Distance Matter?
1) Proxy for Transport Costs.
2) Proxy for ‘Time Elapsed’.
3) Proxy for ‘Transaction Cost’.
6

7. Augmenting the Gravity Model
1) With Income per Capita
o Many estimate gravity equations with the log of per-capita
incomes (lnM=POP) of the exporting and importing
countries included as well as the log of aggregate incomes
(ln M).
1) Adjacency Considerations
o Examples of this phenomenon include India-Pakistan,
Tijuana–San Diego, and HongKong–Shenzhen
1) Languages & Colonial Links
o Two countries that speak the same language will trade more
than pairs that do not share a common language.
o Measures of Colonial Links & Similarity +vely correlated
with Trade.
7

8. Trade Policies & the Gravity Model
1) FTAs lead to tripling of trade between nations (Frankel &
Rose 2000)
2) Mixed results on Monetary Agreements
o Countries that share a common currency trade like US
& Panama three times more than expectation.
o But some other studies have found that the triplingeffect doesn’t pan out similarly with EURO in EU.
1) What about the effect of Import Tariffs or VERs?
8

9. The Ricardian Model
o The Ricardian model uses the concepts of opportunity
o
o
o
o
cost and comparative advantage.
The opportunity cost of producing something measures
the cost of not being able to produce something else with
the resources used.
Example of Comparative Advantage?
o A country has a comparative advantage in producing a
good if the opportunity cost of producing that good is
lower in the country than in other countries. (US in
computers & Bangladesh in textiles)
Project Socrates.
Revealed Comparative Advantage
o (Eij / Eit ) / ( Enj / Ent )
o 1 < (CA) ; >1 (RCA)
9

10. The Ricardian Model
Suppose initially that Bangladesh produces computers and
the U.S. produces textile, and that both countries want to
consume computers and textiles.
Can both countries be better off?
10

11. The Ricardian Model
o
o
o
o
o
o
Labor is the only factor of production.
Labor productivity varies across countries due to
differences in technology, but labor productivity in each
country is constant.
The supply of labor in each country is constant.
Two goods: wine and cheese.
Competition allows workers to be paid a “competitive”
wage equal to the value of what they produce, and allows
them to work in the industry that pays the highest wage.
Two countries: home and foreign.
11

12. The Ricardian Model

The production possibility frontier of the home economy is:
aLCQC + aLWQW ≤ L
Labor required for
each pound of
cheese produced

Total
pounds of
cheese
produced
Total amount of
labor resources
Labor required for
each gallon of
wine produced
Total gallons
of wine
produced
When does one have maximum cheese and maximum wine production?
12

13. Labor Productivity & the Ricardian Model
13

14. Labor Productivity & the Ricardian Model
o
o
o
o
Home has comparative advantage in ____, foreign in _____?
aLC /aLW < a*LC /a*LW
Relative price of ___ to ___ higher in foreign?
Home will ship ___ and foreign14
will ship ____?

15. Labor Productivity & the Ricardian Model
o
o
o
o
Home has comparative advantage in ____, foreign in _____?
aLC /aLW < a*LC /a*LW
Relative price of cheese to wine higher in foreign?
Home will ship cheese and foreign will ship wine?
15

16. Steady State Prices Guided by the Following Rules
If
oPC /PW < aLC /aLW < a*LC /a*LW
home or foreign
then no cheese production at
oPC /PW = aLC /aLW < a*LC /a*LW , then domestic are indifferent,
foreign produces wine.
oaLC /aLW < Pc /PW < a*LC /a*LW , then?
o aLC /aLW < a*LC /a*LW < PC /PW, & now?
16

17. Broadly, Trade Enhances Consumption Possibilities in the
Ricardian World
17

18. Ricardo Tested in China’s Emergence
o China's emergence as an export powerhouse.
o China's overall labor productivity in the mid-90s was still lower than some
American/European standards.
o But in some specific industries, they did have comparative advantage with
the disadvantage dissipating.
o In those industries, it was one of the largest producers and exporters.
o China's relative productivity in apparel was higher than rest of
manufacturing. It had 8 times the size of Germany's apparel industry.
18

19. But Trade Can Happen Not Just because Labor
Productivity Differs
19

20. Could Happen Because Of Differences in Resources
Endowments
20

21. Enter Heckscher-Ohlin Model
21

22. H-O: Broad Intuition from the Nobel Foundation
22

23. H-O: Broad Intuition from the Nobel Foundation
23

24. Notice the H-O set up
o 2 Countries having different relative abundance of factors
of production.
o Production processes use factors of production with
different relative intensity.
o One can classify these countries: home and foreign. Two
goods: cloth and food. Two factors of production: labor
and capital.
o The mix of labor and capital used varies across goods.
o The supply of labor and capital in each country is constant
and varies across countries.
o In the long run, both labor and capital can move across
sectors, equalizing their returns (wage and rental rate)
across sectors.
24

25. H-O Differs from the Ricardian World
o All agents gain from trade in the Ricardian world but is
that true?
o Why then some are anti-trade and some are pro-trade?
o Is a single-factor of production a realistic assumption?
o For that matter 2 factors of production?
o Ricardian world advocates ‘complete specialization’ –
but is that realistic?
o But H-O also extends the Ricardian notion of
‘comparative advantage’ but conditional on resource
endowments – we will shortly see how.
25

26. Samuelson on Comparative Advantage – A Detour
o A mathematician, Stan Ulam, once challenged Paul
Samuelson to name one proposition in the social sciences
that is both true and non-trivial.
o His reply was: ‘the theory of comparative advantage’.
o “That it is logically true need not be argued before a
mathematician; that is not trivial is attested by the
thousands of important and intelligent men (and
women) who have never been able to grasp the doctrine
for themselves or to believe it after it was explained to
them. ”
26

27. Building Blocks: 4 Key Ideas in the H-O Model
1) The Stolper Samuelson Theorem:
o A rise in the relative price of a good will lead to a rise in the
return to that factor which is used most intensively in the
production of the good, and conversely, to a fall in the return to
the other factor.
27

28. Building Blocks: 4 Key Ideas in the H-O Model
2) The Rybczynski theorem:
o When only one of two factors of production is increased there is
a relative increase in the production of the good using more of
that factor. This leads to a corresponding decline in that good's
relative price as well as a decline in the production of the good
that uses the other factor more intensively.
28

29. Building Blocks: 4 Key Ideas in the H-O Model
3) The Factor-Price Equalization Idea
o
The relative prices for two identical factors of production will
eventually
be
equalized
international trade.
29
across
countries
because
of

30. Building Blocks: 4 Key Ideas in the H-O Model
.
4)The Heckscher-Olin Theorem:
o
It states that a country will export goods that use its abundant
factors intensively, and import goods that use its scarce factors
intensively. In the two-factor case, it states: "A capitalabundant country will export the capital-intensive good, while
the labor-abundant country will export the labor-intensive
good."
30

31. Let’s go through the nitty-gritties of H-O: Set-Up Again
Source: Klaus Desmet Lectures
31

32. Production of Food
Source: Klaus Desmet Lectures
32

33. Prices & Uses of Inputs
Source: Klaus Desmet Lectures
33

34. Prices & Relative Uses of Inputs
Source: Klaus Desmet Lectures
34

35. The Lerner Diagram
o This is the lowest possible cost,
an UNIQUE same isocost,
tangent to the two isovalue
curves.
o Here :
• r*Kf + w*Lf = r*Kc +
w*Lc
• Slope = w/r.
• We should be able to find
for each Pf/Pc , w/r
Source: Klaus Desmet Lectures
35

36. Remember Stolper-Samuelson!
1) The Stolper Samuelson Theorem:
o A rise in the relative price of a good will lead to a rise in the
return to that factor which is used most intensively in the
production of the good, and conversely, to a fall in the return to
the other factor.
36

37. Understanding Stolper-Samuelson
o LHS panel indicates relationship between prices and w/r. How?
o RHS panel indicates given w/r, relative use of K/L.
o Pf/Pc
w/r
Kf/Lf & Kc/Lc
Source: Klaus Desmet Lectures
37

38. Allocation of FOPs: The Edgeworth Box Diagram
 Given Pf/Pc, we know
Kf/Lf and Kc/Lc.
 From Origin Of we draw
a line with slope of Kf/Lf
and from Oc with slope
Kc/Lc.
 Intersection
point is
point of allocation of Kf,
Lf, Kc, Lc.
 Can we end up outside
the box? How
Source: Klaus Desmet Lectures
38

39. Recap: Rybczynski Theorem
When only one of two factors of production is increased there is a
relative increase in the production of the good using more of that
factor. This leads to a corresponding decline in that good's
relative price as well as a decline in the production of the good
that uses the other factor more intensively.
39

40. Rybczynski Theorem in a Edgeworth Box
o And you can then take the new Kf/Lf and Kc/Lc to that
2-sided diagram to back out new Pf/Pc
40

41. Rybczynski Theorem through a PPF
41

42. But we have still not discussed H-O’s key idea
A country will export goods that use its abundant factors
intensively, and import goods that use its scarce factors
intensively. In the two-factor case, it states: "A capital-abundant
country will export the capital-intensive good, while the laborabundant country will export the labor-intensive good."
42

43. To understand H-O we need to understand World RS-RD
43

44. Remember our Set-Up Again
Source: Klaus Desmet Lectures
44

45. Remember our Set-Up Again
Source: Klaus Desmet Lectures
45

46. World RS-RD & Autarky
 What is an autarky?
 Examples of autarky in today’s world?
 Synonym for an autarkic economy?
Source: Klaus Desmet Lectures
46

47. H-O, World RS-RD & Free Trade
 Relative prices converge.
 Spain exports computers, Poland food: H-O QED.
Source: Klaus Desmet Lectures
47

48. Gains from Trade & It’s Political Economy






Source: Klaus Desmet Lectures
Spain can export some computers now!
Relative price of food falls in Spain – what about in Poland?
Spain’s real wage ____ and rental rate _____?
Poland’s real wage ____ and rental rate ____ ?
Who will be pro-trade/against-trade in Spain?
In Poland?
48

49. Gains from Trade & It’s Political Economy






Source: Klaus Desmet Lectures
Spain can export some computers now!
Relative price of food falls in Spain – in Poland it rises.
Spain’s real wage falls and rental rate rises.
Poland’s real wage rises and rental rate falls.
Workers in Spain protest.
Capital owners in Poland protest.
49

50. What have we still not covered in H-O?
Source: Klaus Desmet Lectures
50

51. 4th Tenet in H-O : Factor Price Equalization
The Factor-Price Equalization Idea
o
The relative prices for two identical factors of
production will eventually be equalized across
countries because of international trade.
Source: Klaus Desmet Lectures
51

52. FPE explained in a slide
Source: Klaus Desmet Lectures
52

53. FPE explained in a slide
o Since:
o With Free Trade:
o Therefore:
o Or
o Similarly we can show that that the rental rate r also converges.
Source: Klaus Desmet Lectures
53

54. FPE explained in a slide
o Since:
o With Free Trade:
o Therefore:
o Or
o Similarly we can show that that the rental rate r also converges.
Source: Klaus Desmet Lectures
54

55. FPE explained in a slide
o Since:
o With Free Trade:
o Therefore:
o Or
o Similarly we can show that that the rental rate r also converges.
Source: Klaus Desmet Lectures
55

56. FPE explained in a slide
o Since:
o With Free Trade:
o Therefore:
o Or
o Similarly we can show that that the rental rate r also converges.
Source: Klaus Desmet Lectures
56

57. FPE explained in a slide
o Since:
o With Free Trade:
o Therefore:
o Or
o Similarly we can show that that the rental rate r also converges.
Source: Klaus Desmet Lectures
57

58. When can FPE not apply?
o What if there are strategic barriers to trade?
o Could result in incomplete price equalization.
o Or if technology changes – Remember the Trade Contest!
o + Do countries produce both goods always?
58

59. Guess Who?
59

60. Wassily Leontief
60

61. Quiz Question!
61

62. The Leontief Paradox
o Leontief's paradox in economics is that the country with the
world's highest capital-per worker has a lower capital/labor ratio
in exports than in imports. This econometric finding was the
result of Leontief's attempt to test the Heckscher–Ohlin theory
empirically.
o In 1954, Leontief found that the United States—the most
capital-abundant country in the world—exported laborintensive commodities and imported capital-intensive
commodities, in contradiction with Heckscher–Ohlin theory.
o Stern & Maskus (1981) later find that the answer lies by
factoring in a 3rd factor of production.
o Guess which?
o Factoring in
Natural Resources makes the Leontief Paradox
go away – some other day.
62

63. H-O & it’s empirical relevance in Asia
Source: Bowen et.al AER 1987
63

64. H-O & it’s empirical relevance in Asia
 The authors calculated the ratio
of each country's endowment of
each factor to the world supply
of that factor.
 They then compared this ratio
with the country's share of world
income.
 If
FPE is correct, countries
would always export factors, for
which the factor share > income
share.
 But for 2/3rd of the FOPs trade
ran in the predicted direction less
than 70% of time.
Source: Bowen et.al AER 1987
64

65. Asia & ROW trade
65

66. H-O Effect in Bangladesh & German Exports to US
A country will export goods that use its abundant factors
intensively, and import goods that use its scarce factors intensively.
In the two-factor case, it states: "A capital-abundant country will
export the capital-intensive good, while the labor-abundant country
will export the labor-intensive good."
Source: Romalis (2004)
66

67. Rybczynski Effect in the 4 Tigers
When only one of two factors of production is increased there is a relative increase
in the production of the good using more of that factor. This leads to a
corresponding decline in that good's relative price as well as a decline in the
production of the good that uses the other factor more intensively.
Source: Romalis (2004)
67

68. Changing Patterns in Comparative Advantage
 In
1960
4
Tigers
specialized in low-skilled
intensity goods & so was
it in Japan.
 By 1998, the situation was
starting to change in both.
 The role of public policy
68
Source: Krugman et.al (2011)

69. What did we learn today?
1) Trades induces gains.
2) The
principle behind why so, lies in understanding
‘comparative advantage’ & its link to resource endowments.
3) The gravity model is one of the most robust relationships in
economics.
4) Which is why Asia’s intra-regional trade is very high.
5) H-O model has 4 predictions
69

70. What did we learn today?
 The Stolper Samuelson Theorem:
A rise in the relative price of a good will lead to a rise in the return to that
factor which is used most intensively in the production of the good, and
conversely, to a fall in the return to the other factor.
 The Rybczynski theorem:
When only one of two factors of production is increased there is a relative
increase in the production of the good using more of that factor. This leads to
a corresponding decline in that good's relative price as well as a decline in
the production of the good that uses the other factor more intensively.
 The Factor-Price Equalization Idea
Factor Prices Equalize in the long run due to trade.
 The Heckscher-Olin Theorem
Countries exports goods conditional on its resource abundance. Capitalintensive countries will export capital goods (US-computers) and laborabundant country exports the labor-intensive goods (Bangladesh–textiles).
70

71. What did we learn today?
 The Leontief Paradox
 H-O has mixed evidence in Asia. Japan is an exception too
 4-Tigers changes the terms-of-trade over time.
 Next Class: Strategic Trade Policies & Protectionism &
Globalization of the Value Chain & Implications for Trade.
71