Outline

Sources of Comparative Advantage

Econ 340 The Heckscher-Ohlin Model
Main Idea
Intuition
Lecture 4 Does the Theory Work?
Modern Theories and Additional Effects of Trade
Changes in Production
Effects of Trade Factor Price Equalization
The New Trade Theory
Assumptions
Implications
The New New Trade Theory
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Sources of Comparative Advantage Sources of Comparative Advantage

What determines comparative advantage? Factor Proportions
Answer: Many things This will be the most important
Definition: Comparative Well come back to it in a moment
Advantage is
a low price for a good,
in autarky,
relative to other goods
compared to other countries.
Double comparison
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Sources of Comparative Advantage Sources of Comparative Advantage

Technology Demand
This is associated with Ricardo and the High demand for a fixed available quantity
Ricardian model we looked at last time leads to
Technological advantage exports High price, leads to
Advantage may be eroded over time by Comparative Disadvantage
Technology transfer to other countries Thus imports
Multinational companies
Technical progress that makes earlier innovations
obsolete

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Sources of Comparative Advantage Outline
Scale Economies (i.e., Increasing Returns Sources of Comparative Advantage
The Heckscher-Ohlin Model
to Scale) Main Idea
Definition: Average cost falls as output rises Intuition
Leads to lower cost for large countries Does the Theory Work?
Effects of Trade
Problem: scale economies also lead to large Changes in Production
firms, and therefore imperfect competition Factor Price Equalization
(Well deal with this later today, under New Trade The New Trade Theory
Theory) Assumptions
Implications
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The New New Trade Theory
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The Heckscher-Ohlin Model The Heckscher-Ohlin Model

The Factor Proportions Model The Factor Proportions Model
Also called Heckscher-Ohlin Model Main idea:
Due to Comparative advantage is
Eli Heckscher (1879-1952), determined by
Bertil Ohlin (1899-1979), and
Factor endowments of countries,
Paul Samuelson (1915-2009 )
together with
Factor intensities of industries

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The Heckscher-Ohlin Model The Heckscher-Ohlin Model

Two differences drive trade in H-O Model Two differences drive trade in H-O Model
1. Countries differ in endowments of factors 1. Countries differ in endowments of factors
2. Industries differ in factor intensities Labor
Capital
Land
Skill (Human capital)
Resources
2. Industries differ in factor intensities
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 The Heckscher-Ohlin Model The Heckscher-Ohlin Model
1. Countries differ in endowments of factors Implication of #1 and #2:
2. Industries differ in factor intensities Heckscher-Ohlin Theorem:
Examples:
Countries have comparative advantage in,
Agriculture uses lots of land
Textiles & apparel use lots of unskilled labor and therefore export,
Autos use lots of capital goods that use relatively intensively
Computers use lots of human capital their relatively abundant factors

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The Heckscher-Ohlin Model The Heckscher-Ohlin Model

Implication of #1 and #2: Intuition
Abundant factors are cheap (in autarky)
Heckscher-Ohlin Theorem: Cheap factors produce cheap goods
Countries have comparative advantage in, Hence comparative advantage
Crucial for the model:
and therefore export,
Factors (labor, capital, etc.) are perfectly mobile
goods that use relatively intensively within a country across industries
Thus all labor is paid the same wage wages, etc.,
their relatively abundant factors do not differ by industry.

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The Heckscher-Ohlin Model The Heckscher-Ohlin Model

Does the H-O Theory Work?
Does the H-O Theory Work Empirically?
Evidence in favor
Evidence against
US exports agricultural goods and high-tech goods,
Leontief Scarce Factor Paradox intensive users of our abundant land and human capital
In early 1950s, Wassily Leontief (1906-1999) measured Developing countries export textiles and apparel, intensive
capital (K) and labor (L) in US exports (X) and imports (M).
in unskilled labor
Found:
Paradox, Most recent studies have found increasing evidence that
US US
since US
KX K trade patterns do depend on
was
thought to
< M Factor proportions, as the H-O theory says,

have LX exports LM imports But also on differences in technology

abundant Conclusion:
capital H-O theory is an important part of the story,
More recent studies have been mixed.
But it is not the whole story
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 Effects of Trade
Outline
(according to H-O Theory)
Sources of Comparative Advantage Trade causes:
The Heckscher-Ohlin Model Production: of export good
Main Idea
of import good
Intuition
Does the Theory Work? Factors (labor, capital, etc.) to move industries:
Effects of Trade toward export sector
Changes in Production Industries expand, contract, or may disappear
Factor Price Equalization (as in Ricardian model)
The New Trade Theory Factor demands: for abundant factor
Assumptions for scarce factor
Implications Factor prices: for abundant factor
The New New Trade Theory
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Modern Theories factor 20

Effects of Trade
(according to H-O Theory) Wolfgang Stolper and Paul Samuelson
Two important implications for factor prices:
Factor Price Equalization
Trade causes prices of factors in different countries to move
together, even to become equal across countries
Stolper-Samuelson Theorem
Real price (i.e., wage in terms of goods it can buy) of a
countrys abundant factor rises due to trade
Real price (wage) of its scarce factor falls

NOTE: This means that there are losers from trade: the
owners of a countrys scarce factor.
(In the US, that is (unskilled) labor)
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Effects of Trade Effects of Trade

(according to H-O Theory) (according to H-O Theory)
Implications of the Stolper-Samuelson Theorem Implications of the Stolper-Samuelson Theorem
See Bivens What should we do about it?
If the Stolper-Samuelson Theory is right for the US, Bivens, though himself a trade critic, does not say to restrict
then labor loses from trade trade
He advocates other policies to redistribute income toward
Thats a lot of people, perhaps a majority of the low-wage workers
population large-scale social insurance programs
And it implies increased inequality universal health care
stable pension income
disability and life insurance
lifetime of access to high-quality public education

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 Outline The New Trade Theory
Sources of Comparative Advantage New Trade Theory
The Heckscher-Ohlin Model
Main Idea Developed in the early 1980s
Intuition Most prominent contributor was Paul
Does the Theory Work? Krugman, now a New York Times columnist
Effects of Trade Won Nobel Prize 2008
Changes in Production
Factor Price Equalization
The New Trade Theory
Assumptions
Implications
The New New Trade Theory
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The New Trade Theory The New Trade Theory

Assumptions of the New Trade Theory Implications of the New Trade Theory
One or more of 1. Countries may export the same good to each
Increasing returns to scale other
Imperfect competition
2. Countries may lose from trade
Monopoly (one seller)
Oligopoly (few sellers) 3. More and broader reasons for countries to
Monopolistic competition (many sellers, but each with some gain from trade
market power)
4. New rationales for using policy to affect trade
Product differentiation
None of these were allowed in the Ricardian and
H-O Models More on each of these
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The New Trade Theory The New Trade Theory

1. Countries may export the same good to 1. Countries may export the same good to
each other each other
This is called Intra-Industry Trade (IIT) This is called Intra-Industry Trade (IIT)
Example: US both exports and imports cars Example: US both exports and imports cars

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 The New Trade Theory The New Trade Theory
Explanations for IIT Explanations for IIT
Definitions of industry may be too large, Same good sold across different borders
and include
Different, but similar, products
Toyotas
Fords
Goods at different stages of processing
Autos
Auto parts

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The New Trade Theory The New Trade Theory

Explanations for IIT Explanations for IIT
Same good sold across different borders Differentiated products the same, but
advertised as different (brands of jeans)

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The New Trade Theory The New Trade Theory

Explanations for IIT Explanations for IIT
Identical products sold by firms from Identical products sold by firms from
different countries into each others markets different countries into each others markets

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 The New Trade Theory
2. Countries may lose from trade
This is not actually likely, but it wasnt even
possible in the Ricardian and H-O Models
One story: small country may be forced to
specialize in an industry with decreasing
returns to scale
The New Trade Theory
3. More and broader reasons for countries to gain
from trade
New gains from each new assumption:
Cost reductions due to scale economies
Reduced market distortions due to increased competition
Consumer benefit from access to more variety
Implication: It is possible for all people in a country
to gain from trade
Contrast to H-O Model and Stolper-Samuelson Theorem,
where somebody must lose

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The New Trade Theory The New Trade Theory

4. New rationales for using policy to affect Strategic Trade Policy: Boeing-Airbus Game
trade P=produce, N=not produce Equil. If Boeing moves first,
since now Airbus will not
Called Strategic Trade Policy See No subsidy, enter
Krugman article Airbus
Payoff
How? Boeing choice:
Matrix P N
If some industries are better to have than others depends on
(due perhaps to scale economies), industrial Airbus 5 0
policy may promote these industries P
5 100
If imperfectly competitive firms earn profits, Boeing
trade policy may be used to get more profit for a 100 0
countrys own firms N
0 0
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The New Trade Theory The New Trade Theory

Strategic Trade Policy: Boeing-Airbus Game Strategic Trade Policy: Boeing-Airbus Game
P=produce, N=not produce P=produce, N=not produce Equil. With no
subsidy if Boeing
No subsidy, Airbus Subsidy = +10 No subsidy, Airbus Subsidy = +10 moves first
Airbus Airbus
Now Airbus Equil. with
choice does P N subsidy and P N
exit
not depend on 5 (+5) 0 5 (+5) 0
Boeing P P
5 100 5 100
Boeing Boeing
100 (110) 0 100 (110) 0
N N
0 0 0 0
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 The New Trade Theory The New Trade Theory
Boeing-Airbus Game results 4. New rationales for using policy to restrict
If Boeing moves first, without subsidy Airbus trade
will not enter But note Krugmans conclusion: These
Boeing and US gain +100 arguments are not likely to be usable:
Airbus and EU gain 0 Empirical difficulties: Hard to know where to
If EU pays subsidy, Airbus will enter and intervene
Boeing will exit Entry: Benefits will be dissipated by new firms
Airbus gains 110, EU gains 100 (=100-10) General equilibrium: Help in some sectors hurts
Boeing and US gain 0 others
Retaliation: Other countries may react
Thus EU gains and US loses from EU subsidy
Political economy: Industries lobby for help
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Outline The New New Trade Theory

Sources of Comparative Advantage Heterogeneous Firms
The Heckscher-Ohlin Model Due to Marc Melitz (UM Phd 2000)
Main Idea
Intuition Assumes that firms within an industry differ in
Does the Theory Work? productivity (+ other assumptions of New
Effects of Trade Trade Theory)
Changes in Production
Factor Price Equalization
The New Trade Theory
Assumptions
Implications
The New New Trade Theory
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The New New Trade Theory Next Time

Heterogeneous Firms (Melitz Model) Tariffs
Implications: What are they and how are they used?
More productive firms are larger & earn more
profits What effects do they have?
Opening to freer trade causes Theory: Supply and Demand
Most productive firms to expand and export Data
Least productive firms to shut down
Thus average productivity rises
Yet another new source of gain from trade!
Also new losers: Those in least productive
firms
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