International Economics Faculty: Prof. D. Sunitha Raju Extension to the Basic Trade Model: Some...

International Economics

Faculty:Prof. D. Sunitha Raju

Extension to the Basic Trade Model: Some Empirical Issues


Factor Endowments: Heckscher – Ohlin theorem

Why differences in Relative Prices? Or what determinescomparative advantage?

Factor intensity / abundance, technology and factor prices

Trade influences factor earnings


Heckscher-Ohlin Theorem

A nation will export the commodity whose production requires the intensive use of the nation’s relatively abundant factor and import the commodity whose production requires intensive use of nation’s relatively scarce factor (costly).

Factor endowments are basic determinants of comparative advantage

Factor abundance and their prices are a cause for difference in relative commodity prices


Factor Intensity

(a) Assume:• Two commodities x & Y • Two factors L & K

(b) Capital Intensive Production• If capital – labour ratio (K/L) is greater in the

production Y than in the production of X. Then Y is capital intensive.

(c) Labour Intensive Production• If K/L is lower in the production of X than in the

production of Y then X is labour intensive


0 0

Nation 1 Nation 2

2 4 6 8 10 12

1Y2

4

6

8

10

.1 2 4 6

.2

1

4

6

.2X

1X

2Y

L

K

LK

41

inXLK

in Y = 1

K

L

.

1Y

2Y

1X

2X

LK

in Y = 4

1inXLK

Factor Intensities for Commodities X and Y in Nations 1 & 2


Factor Price Equalisation

International trade will bring about equalization in the relative and absolute returns to the homogenous factors across nations.

Trade is a substitute for mobility of factors

Trade tends to reduce pre-trade differences in w and r between two countries


Factor Endowments of Various Countries and Regions, as a Percentage of the World Total in 1993

Country / Region

Capital Skilled Labor Unskilled Labor

All Resources

United States 20.8% 19.4% 2.6% 5.6%European Union

20.7 13.3 5.3 6.9

Japan 10.5 8.2 1.6 2.9Canada 2.0 1.7 0.4 0.6Rest of OECDa 5.0 2.6 2.0 2.2

Mexico 2.3 1.2 1.4 1.4Rest of Latin America

6.4 3.7 5.3 5.1

China 8.3 21.7 30.4 28.4India 3.0 7.1 15.3 13.7Hong Kong, South Korea, Taiwan, Singapore

2.8 3.7 0.9 1.4

Rest of Asia 3.4 5.3 9.5 8.7

Contd./-

International Economics Country / Region

Capital Skilled Labor Unskilled Labor

All Resources

Eastern Europe (including Russia)

6.2 3.8 8.4 7.6

OPECb 6.2 4.4 7.1 6.7Rest of the World

2.5 4.0 10.0 8.9

Total 100.00 100.0 100.0 100.0

a OECD = Organization for Economic Cooperation and Development, which includes all the other industrial countries.

b OPEC = Organization of Petroleum Exporting Countries.

Source: Elaboration on W.Cline, Trade and Income Distribution (Washington, D.C.: Institute of International Economics, 1997, pp. 183-185


Capital Stock per Worker of Selected Countries in 1993 (in 1990 International dollar prices)a

Developed Country 1993 Developing Country 1993

Japan 77,429 Korea 26,635

Germany 61,673 Chile 17,699

Canada 61,274 Mexico 14,030

France 59,602 Turkey 10,780

United States 50,233 Thailand 8,106Italy 48,943 Philippines 6,095Spain 38,897 India 3,094

United Kingdom 30,226 Kenya 1,412


Export/Import Ratios in Leading Industrial Countries

Country Technology Intensive

Services Standardized Labor Intensive

Primary Products

United States

1.52 1.47 0.39 0.38 0.55

Japan 5.67 0.73 1.09 1.04 0.04West Germany

2.40 0.80 0.84 0.59 0.29

France 1.38 1.32 1.03 0.86 0.52

United Kingdom

1.39 1.19 0.76 0.71 0.81

Canada 0.77 0.50 1.38 0.20 2.21


Export/Import Ratios in Manufacturing in Selected Asian Countries in 1993

a Part of Chinab Province of ChinaSource: United Nations Conference on Trade and Development, Trade and Development Report (New York: UN, 1995), p.150.

Country Technology-Intensive

Physical Capital-

Intensive

Human Capital-

Intensive

Unskilled Labor-

IntensiveJapan 1.60 1.29 1.44 0.39China 0.56 0.43 0.47 3.58Hong Konga 1.21 0.29 0.63 3.50

Taiwanb 1.53 0.64 0.68 2.15Korea 1.38 0.72 0.97 1.95Singapore 2.35 0.63 0.31 0.53Indonesia 0.21 0.15 0.24 1.88Malaysia 1.84 0.36 0.34 0.70Thailand 1.06 0.35 0.43 2.02


• Export and import correspond to the same industry

• Expansion of IIT- Differentiated products- Transportation costs- Production processes divided across countries

Intra-Industry Trade


Shares of Intra-Industry Trade in Manufactured Products, Selected

Industrial Country 1970 1987 Developing Country

1970 1987

United States 55.1 61.0 India 22.3 37.0

Japan 32.8 28.0 Brazil 19.1 45.5

Germany 59.7 66.4 Mexico 29.7 54.6

France 78.1 83.8 Turkey 16.5 36.3

United Kingdom 64.3 80.0 Thailand 5.2 30.2

Italy 61.0 63.9 Korea 19.4 42.2

Canada 62.4 71.6 Argentina 22.1 36.4

Spain 41.2 67.4 Singapore 44.2 71.8

Average 56.8 65.3 Average 22.3 44.3

Source: J. A Stone and H.H. Lee, “Determinants of Intra-Industry Trade: A Longitudinal, Cross Country Analysis,” Weltwirtschaftliches Archiv, No. 1, 1995, p.70


Intra-Industry Trade (IIT)

a) Export and import of goods from the same industryb) Measure of IIT IIT = 1 -

c) IIT ranges from 0 to 1

Exports - ImportsExports + Imports


Intra-Industry Trade Indexes, 1985

High-Income Countries

IIT Index Middle-Income Countries

IIT Index Low-Income Countries

IIT Index

United States .1371 Israel .0721 Thailand .0286

Canada .0550 Spain .0807 Dominican Republic

.0120

Australia .0306 Ireland .0746 Sri Lanka .0186

West Germany .1473 Taiwan .0569 Philippines .0240

Belgium-Luxembourg

.1347 South Korea .0644 India .0305

Average .0876 Average .0274 Average .0089


Intra-Industry Trade

a) In homogenous products– Transportation costs– Seasonality

b) In differentiated products– Vertical specialization in breaking up of production chain


Ratio of Merchandise Trade to Merchandise Value-Added, 1980, 1990, 2000 (per cent)

Country 1980 1990 2000Major industrialized economies 46.2% 51.6% 76.3% Canada 63.7 70.6 108.8

Germany 52.0 63.7 96.7

Japan 28.7 20.6 24.2

United States 30.9 35.1 54.6

Emerging market economiesAsia 93.8 115.6 168.5

China 12.1 23.7 32.9

India 11.3 12.4 21.6

Hong Kong, Korea, Singapore, Taiwan 216.5 259.3 365.5

Bangladesh, Indonesia, Malaysia, Pakistan, Philippines, Thailand

39.4 52.4 84.3

Brazil 19.4 14.6 34.1

Mexico 22.8 48.3 102.6


Trade with Economies of Scale

a) Internal Economies of Scale

b) External Economies of Scale

c) Dynamic External Economies


Trade based on Economies of Scale

International Economies of ScaleExternal Economies of Scale

..

0 20 40 60 80 100 120

20

40

60

80

100

120

A

E

B X

Y

I

II

B’

PA


Transport Costs and Trade

a) High Transport Costs can impede trade– Limits vertical specialization– Can alter the pattern of trade through price effects

b) Who bears the burden– Importer or exporter

International Economics Faculty: Prof. D. Sunitha Raju Extension to the Basic Trade Model: Some...

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