ECON7530

Lecture 5
Resources and Trade:
The Heckscher-Ohlin Model (Part 2)
Nhan Phan
UQ School of Economics
Video Group Assignment – Format
See the ECP’s Section 5 – Assessment for details.
Criteria & Marking (Rubric to come in Week 8)
• Amount of research shown
• Information accuracy
• Argument strengths in the third task
• Individual presentation
Note all members are sharing the marks for ALL criteria except for
Individual presentation.
• Please get involved in the research/script writing process.
Video Group Assignment – Some Tips
• You have now been allocated in a group of 3-5 members.
• Let me know if your group has less than 3 members.
• Hopefully, you have also met your groupmates by now. If not:
• Make an arrangement to meet in person, or if not possible, at least
on Zoom (with videos on).
• It is always better to interact with group members when you see their faces.
• Next Monday, I will release the Buddycheck link.
• https://web.library.uq.edu.au/library-services/it/learnuq-blackboard-
help/learnuq-assessment/buddycheck
• Remember, this group assignment is about compromise as much as
about content.
Last Week – Summary
• 2x2x2 Heckscher-Ohlin model
• Trade occurs due to differences in labor, labor skills, physical capital, capital,
or other factors of production across countries.
• Stolper-Samuelson theorem
• Rybczynski theorem
Learning Objectives
• Explain how differences in resources generate a specific pattern of
trade. (Last week)
• Discuss why the gains from trade will not be equally spread even in
the long run and identify the likely winners and losers.
• Understand the possible links between increased trade and rising
wage inequality in the developed world.
• See how empirical patterns of trade and factor prices support some
(but not all) of the predictions of the factor-proportions theory.
 Part 1
Trade in the Heckscher-Ohlin Model

Source: rawpixel.com
Last Week – The 2x2x2 Model
• Two countries: Home and Foreign.
• Two factors of production: Labour and Capital.
• Two goods: Cloth and Food.
• Cloth is labour intensive; Food is capital intensive
• Home is relatively abundant in labour;
• Foreign is relatively abundant in capital
• ➔ Home is relatively more efficient in producing cloth
• ➔ Foreign is relatively more efficient in producing food
UQ Extend – Further Assumptions
The countries are assumed to have the same technology and the same
tastes.
• Same technology: each economy has a comparative advantage in
producing the good that relatively intensively uses the factors of
production in which the country is relatively well endowed.
• Same tastes: the two countries will consume cloth to food in the
same ratio when faced with the same relative price of cloth under
free trade.
UQ Extend – Relative Supply
• Cloth is relatively labour intensive,
and Home is relatively abundant in
labour
➔ At each relative price of cloth to
food, Home will produce a higher
ratio of cloth to food than Foreign.
• Home will have a larger relative
supply of cloth to food than Foreign.
• ➔ Home’s relative supply curve lies
to the right of Foreign’s.
UQ Extend
Trade in the Heckscher-Ohlin Model
• The H-O model predicts a convergence
of relative prices with trade.
• The relative price of cloth:
• rises in the relatively labor abundant
(Home) country
• falls in the relatively labor scarce (Foreign)
country.
• In Home, the rise in the relative price
of cloth leads to:
• a rise in the relative production of cloth
• a fall in relative consumption of cloth.
• Home becomes an exporter of cloth
and an importer of food.
 UQ Extend
Trade in the Heckscher-Ohlin Model
• Heckscher-Ohlin theorem: The
country that is abundant in a factor
exports the good whose production
is intensive in that factor.
Generalises to a correlation:
• Countries tend to export goods
whose production is intensive in
factors with which the countries Source: Adobe Stock
are abundantly endowed.
Sneak Peek: New Relative Supply Curve
Relative Price of Cloth
𝑃𝐶 𝑅𝑆 𝑊𝑜𝑟𝑙𝑑
𝑃𝐹
𝑅𝑆 ∗
𝑅S

3
𝑃𝐶
𝑃𝐹
Relative Price of Food
Decreases in Foreign
2
𝑃𝐶
𝑃𝐹
Relative Price of Food
1
Increases in Home 𝑃𝐶
𝑃𝐹

𝑅𝐷
𝑄𝐶
Relative Quantity of Cloth 𝑄𝐹
UQ Extend
Trade and the Distribution of Income
Changes in relative prices can affect
the earnings of labour and capital.
• Stolper-Samuel theorem: A rise in
the price of cloth:
• raises the purchasing power of labour
in terms of both goods
• lowering the purchasing power of
capital in terms of both goods.
• A rise in the price of food has the
reverse effect.
UQ Extend
Trade and the Distribution of Income
Thus, international trade can affect the distribution of income, even in
the long run
• Owners of a country’s abundant factors gain from trade;
• But owners of a country’s scarce factors lose.
• Factors of production that are used intensively by the import-
competing industry are hurt by the opening of trade – regardless of
the industry in which they are employed.
• In our example: workers in Home country gain from trade, while
capital owners lose from trade
• Why? Home is labour abundant & export cloth, a labour-intensive product
UQ Extend
Trade and the Distribution of Income
• From a welfare point of view, it would be better to compensate the
losers from trade (or any economic change) than prohibit trade.
• The economy as a whole benefits from trade.
• Collective action problem: 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.
 Collective
Action Problem
Source: https://www.fwi.co.uk/news/farm-policy/farmers-to-protest-
against-australia-tariff-free-trade-deal
SBF founder and farmer’s wife Liz Webster said the group
was contacting local farmers about organising the protest.
“We have the fight of our lives to save our British values.

“If this [Australia] deal happens without tariff and quota

protections for our industry, then our beautiful
countryside and safe British food will be gone forever.”

[…] Farm leaders fear signing a free-trade deal with

Australia could trigger a “domino effect” of similar trade
deals with global agricultural powerhouses such as Brazil
and the US, which will leave UK farmers unable to
compete and risks their livelihoods.
Figure: Evolution of U.S. Non-Production–
Production Employment Ratios in Four Groups of
Sectors

Source: NBER-CES Manufacturing Productivity Database.

 Skill-Biased Technological Change
and Income Inequality
• In many developed economies,
there is a widespread increase in
the skilled labour ratios, pointing
to the skill-biased technological
explanation.
• But this cannot be attributed to
trade alone.
• Trade likely has been an indirect
contributor, by accelerating the
process of technological change.
Capital–Skill Complementary
• Worldwide phenomenon: trend
toward lower labour income share
(and higher capital shares).
• Can be explained due to
technological change (e.g.
increased automation).
• New and better machines (capital).
• Displace unskilled workers but still
require skilled workers. Unweighted world average for all 59 countries with
• Generates higher returns for both available data.
capital and skilled workers. Source: Loukas Karabarbounis and Brent Neiman, “The
Global Decline of the Labor Share,” The Quarterly
• Decreasing the returns to unskilled Journal of Economics 129.1 (2014), pp. 61–103.
workers.
UQ Extend – Factor Price Equalisation
• The Stolper-Samuelson theorem states
that there is a relationship between
relative prices of goods and the relative
prices of factors of production.
• Note that the Heckscher-Ohlin model
predicts a convergence of relative
prices with trade.
• Then, this implies that the relative
wages of both countries will also
converge:
𝑃𝐶 𝑃𝐶∗ 𝑤 𝑤∗
= ∗ ⇒ = ∗
𝑃𝐹 𝑃𝐹 𝑟 𝑟
• See UQ Extend for the intuition.
 Factor Price Equalisation – Reality
• This would imply that relative Country
Hourly Compensation of Manufacturing Workers 2016
(United States = 100)
wage should be the same Switzerland 154.64
across Australia, U.S., China Germany 110.63
United States 100.00
and Bangladesh. United Kingdom 72.79
• However, this is not true in Japan 67.80
South Korea 58.87
the real world. Why? Argentina 42.97
Greece 40.22
Portugal 28.08
Czech Republic 27.43
Poland 21.83
Brazil 20.45
Turkey 15.61
Source: The Conference Board, Mexico 10.02
International Labor Comparisons. Philippines 5.27
UQ Extend – Factor Price Equalisation
Three crucial assumptions are untrue in reality:
1. Production technologies are the same in every country.
• Advanced economies can have a higher wage rate and a higher rental rate
due to superior technologies
2. Costless trade completely equalises the prices of goods in the two
countries.
• Transportation costs
• Barriers to trade (tariffs, import quotas, etc.)
3. Both countries produce both goods.
• Countries might be induced to specialise in the production of different goods.
 Part 2
Testing the Heckscher-Ohlin Model
Theory is when you know everything, but nothing works
Practice is when everything works, but no one knows why
When you combine theory and practice: nothing works, and no one knows why
-Unknown-

Source: Adobe Stock

Empirical Evidence
Tests on U.S. data
• Leontief (1953) found that U.S. exports were less capital-intensive
than U.S. imports, even though the United States is the most capital-
abundant country in the world: Leontief paradox.
Tests on global data
• Bowen, Leamer, and Sveikauskas (1987) tested the Heckscher-Ohlin
model on data from 27 countries and confirmed the Leontief paradox
on an international level.
Factor Content of U.S. Exports and Imports
for 1962
Imports Exports
Capital per million dollars $2,132,000 $1,876,000
Labor (person-years) per million dollars 119 131
Capital-labor ratio (dollars per worker) $17,916 $14,321
Average years of education per worker 9.9 10.1
Proportion of engineers and scientists in work force 0.0189 0.0255
Source: Robert Baldwin, “Determinants of the Commodity
Structure of U.S. Trade,” American Economic Review 61 (March
1971), pp. 126-145.
Empirical Evidence – Missing Trade
• The H-O Model predicts volumes of trade between different countries
based on their relative abundance of factors of production
• For example: In 2011, the U.S. has 25% of global GDP but only 5% of
the global labor supply ➔ the U.S. is very scarce in labour.
• The HO model predicts that the U.S. will import a lot of “labour” embodied in
a high volume of imports of labour-intensive goods and services.
• Trefler (1993) – the volume of trade between labor-abundant
countries and capital-abundant countries is 100 to 1000 times less
than that implied by the “vanilla” HO model
• There is a lot of “Missing Trade” if the vanilla HO model holds.
Empirical Evidence – Missing Trade
• Trefler (1993) demonstrated that both the Leontif Paradox and the
Missing Trade can be explained in large part as being due to
differences in technology employed across countries.
• Suppose workers in capital-abundant countries (such as the U.S.) are
more productive than workers in labor-abundant countries
• The effective labor supply in capital-abundant countries is greater
than a simple headcount of workers might suggest.
Estimated Technological Efficiency, 1983

Country
Bangladesh 0.03
Thailand 0.17
Hong Kong 0.40
Japan 0.70
West Germany 0.78
United States 1
Source: Daniel Trefler, “The Case of the Missing Trade and
Other mysteries,” American Economic Review (December 1995),
pp. 1029–1046.
Empirical Evidence
• Davis and Weinstein (2001) show that if these assumptions were
relaxed:
1. common technologies
2. assumptions underlying factor price equalization (countries produce the
same goods and costless trade equalizes prices of goods)
• Then, the predictions for the direction and volume of the factor
content of trade line-up well with empirical evidence and ultimately
generate a good fit.
• Difficulty finding support for the predictions of the “pure” Heckscher-
Ohlin model can be blamed on some of the assumptions made.
Empirical Evidence
Assumptions Assumptions Assumptions Assumptions
Dropped Dropped Dropped Dropped
None Drop (1) Drop (1)-(2) Drop (1)-(3)
Predictive Success
0.32 0.50 0.86 0.91
(sign test)
Missing Trade
0.0005 0.008 0.19 0.69
(observed/predicted)

Assumptions: (1) common technologies across countries; (2) countries produce the same set of
goods; and (3) costless trade equalizes goods prices.

Source: Donald R. Davis and David Weinstein, “An Account of Global Factor Trade,” American Economic Review
(2001), pp. 1423–1453.
Figure: Export Patterns for a Few Developed
and Developing Countries, 2008–2012

Source: NBER-CES U.S. Manufacturing Productivity Database, U.S. Census Bureau, and Peter K. Schott, “The Relative Sophistication of
Chinese Exports,” Economic Policy (2008), pp. 5–49.
Empirical Evidence
Contrast the exports of labor-abundant, skill-scarce nations in the
developing world with the exports of skill-abundant, labor-scarce (rich)
nations.
• The exports of the three developing countries to the United States are
concentrated in sectors with the lowest skill intensity.
• The exports of the three skill abundant countries to the United States
are concentrated in sectors with higher skill intensity.
Figure: Changing Pattern of Chinese Exports
over Time

Source: NBER-CES U.S. Manufacturing Productivity Database, U.S. Census Bureau, and Peter K. Schott, “The Relative
Sophistication of Chinese Exports,” Economic Policy (2008), pp. 5–49.
Empirical Evidence
Overtime, as China grows and becomes relatively more skill-abundant:
• The concentration of exports in high-skill sectors steadily increases
over time.
• In the most recent years, the greatest share of exports is transacted in
the highest skill-intensity sectors.
• Exports were concentrated in the lowest skill-intensity sectors in the
earlier years.
Empirical Evidence – Summing Up
• Cases against the Heckscher-Ohlin model
• Leontief paradox: confirmed on a global scale
• Factor-price equalisation
• The Case of Missing Trade: Trefler (1993)
• Overall, the main problem comes from the very strong assumptions
of the Heckscher-Ohlin model.
• The model predicts well for cases involving trade between high-
income countries and low/middle- income countries or when
technology differences are included.
• Different skillsets for labour.
Empirical Evidence – Summing Up
Nevertheless, the model remains important for understanding the
effects of trade (distribution of income)

Source: Adobe Stock

Summary
• An economy exports goods that are relatively intensive in its relatively
abundant factors of production and imports goods that are relatively
intensive in its relatively scarce factors of production.
• Owners of abundant factors gain, while owners of scarce factors lose with
trade.
• A country as a whole is predicted to be better off with trade, so winners
could in theory compensate the losers within each country.
• The Heckscher-Ohlin model predicts that relative output prices and factor
prices will equalize, neither of which occurs in the real world.
• Empirical support of the Heckscher-Ohlin model is weak except for cases
involving trade between high-income countries and low/middle- income
countries or when technology differences are included.