International Trade Models and Their Implications
Theories that will be considered are:
- The Heckscher-Ohlin model of trade
- An economy of scale model of trade
- A product differentiation model of trade
- A transportation cost model of trade
- An environmental standards model of trade
The Heckscher-Ohlin Theory
The Heckscher-Ohlin theory is based on two subsidiary theorems:
- The H-O nation will export the commodity whose production requires the intensive use of the nation’s relatively abundant, and therefore cheap, factor and import the commodity whose production requires the intensive use of the nation’s relatively scarce and therefore, expensive factor. In other words, relative factor abundance drives comparative advantage and the pattern of trade.
- International trade will bring about equalization in the relative and absolute returns to homogenous factors across nations. In other words, wages and other factor returns will be the same after specialization and trade has occurred.
Suppose that there are 2 countries with identical technology and societal preferences. The nations differ in that one is relatively labor abundant and the other is relatively capital abundant. K-L- The country with greater K/L ratio is the one defined as being capital abundant. Further, the commodities produced differ in factor intensity. Factor intensity is determined by the K/L required for the production of the commodity. The commodity requiring the greater K/L ratio per unit of production is defined as being capital intensive.
NATION 1 LABOR ABUNDANT-labor intense X
NATION 2 IS CAPITAL ABUNDANT- CAPITAL INTENSE Y
In the H-O model of trade, the pattern of trade is driven by relative factor abundance. Labor abundant countries export goods that are labor intensive in their production. Capital abundant countries export goods that are capital intensive in their production.
Exported products experience an increase in their price relative to the autarky (non-trade) situation.
The Stolper-Samuelson theorem demonstrates that an increase in the relative price of a commodity raises the return of the factor used intensively in its production.
At the same time, the return of the relatively scarce factor will fall.
The conclusion of worsened inequality in the developed world holds only if:
- The assumptions of the H-O theory hold.
As will be seen, this may not be the case.
- The Stolper-Samuelson theorem is the only force driving changes in inequality.
In 1951, Leontief Paradox showed that the pattern of trade did not fit the conclusions of the H-O theorem, imports in the US were capital intensive when they should have been labor intensive.
An Economy of Scale Model of Trade
Economy of scale means the production at a large scale, more output, can be achieved at a lower cost. When an industry has these characteristics, specialization and trade can result in improvements in world productive efficiency and welfare benefits that accrue to all trading countries.
For example, the USA, Japan, and the EU, they are similar countries in terms of technology, to some extent similar preferences, could be identical and at the same time, it is beneficial to trade between them.
Can lead to monopolies or oligopolies.
Outsourcing – Letting others produce for you.
Offshoring – Producing abroad in own facilities.
+ not responsible, fewer costs, convenience
– higher developing, less control
+ full control
– responsible, investment risks
Transportation Costs in Trade
The introduction of transportation costs into the standard model of trade may eliminate a country’s comparative advantage in the production of an item.
Transportation costs are the freight charges, warehousing costs, costs of loading and unloading, insurance premiums, and interest charges incurred while goods are in transit between nations.
Differentiated Products
Intra-Industry Trade
Reasons for intra-industry trade: allows consumers to benefit from the product variety that would not exist without international trade and allows producers to exploit product-specific economies of scale.