ECON2915 Economic Growth Lecture 11 : The Heckscher-Ohlin Model. - PowerPoint PPT Presentation

ECON2915 Economic Growth Lecture 11 : The Heckscher-Ohlin Model. Andreas Moxnes University of Oslo Fall 2016 1 / 36

Introduction Recall, in specific-factors model: Two products (e.g. agriculture and manufacturing) and two inputs (e.g. labor and capital). One factor is immobile − → Return on immobile factor (e.g. capital return r ) not equal across industries. But in the long run, most inputs are mobile. Differences in returns r means that capital will reallocate. E.g. investment in one sector and capital depreciation in other sector. This lecture: Analyze 2x2x2 model (countries, factors, products). All factors mobile. Enables us to analyze long-run ◮ Effect of trade on GDP ◮ Who gains/loses from trade. ◮ 3 important (and classic) trade theorems. 2 / 36

Four facts 1 Since the 1970’s, the US economy has more than doubled. Along with this, labor productivity grew. 2 Over the same period, wages started to lag behind productivity growth. 3 Inequality in wages also increased; median wages have been stagnant, and below-median male wages have fallen. 4 This coincides with the big wave of globalization. Did globalization cause this? We can use the H-O model to analyze the theoretical mechanisms. 3 / 36

Facts 1 & 2 (1992=100) 4 / 36

Fact 3 Real wages for U.S. men by decile: 5 / 36

Today 6 / 36

Norway : Income inequality After-tax household income, all individuals except students. Share of income going to the x’th decile (1986=100): 150 140 130 10 20 30 120 40 50 60 110 70 80 90 100 100 90 80 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 7 / 36

Norway : Median real income After-tax household income: 180 170 160 150 140 130 120 110 100 90 80 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 8 / 36

The Model Comparative-advantage model in which trade is driven by differences in factor endowments across countries. Let’s assume there are only two countries: US and China. Two goods: Apparel ( Q A ) and Plastics ( Q P ). Two factors of production: Skilled and unskilled labor. 9 / 36

The Model First, we’ll go through the model with fixed-coefficients production (Leontieff) because it’s easier to understand that way. Later, we’ll go through it with general CRS production functions. Throughout, we assume that each country’s factor supplies are fixed; ◮ Each factor is mobile within its country (no specific factors); All agents take prices as given. 10 / 36

Factor intensities Produce 1 unit of apparel : ◮ Requires 1 unit of skilled labor ( a SA ) and 2 units of unskilled labor ( a UA ). Produce 1 unit of plastics : ◮ Requires 3 units of skilled ( a SP ) and 3 units of unskilled labor ( a UP ). Which product is skilled-labor intensive? 11 / 36

Factor endowments Assume that the US has 72 million unskilled workers ( L U ), 60 million skilled workers ( L S ). Assume that China has 540 million unskilled workers, 300 million skilled workers. − → Which country is skilled-labor abundant (unskilled-labor scarce). 12 / 36

Supply : US Denote output Q A and Q P . Unskilled labor market clearing: 2 Q A + 3 Q P = L U = 72 million Skilled labor market clearing: Q A + 3 Q P = L S = 60 million Two equations and two unknowns. 13 / 36

Supply : US Each curve gives combination of ( P , A ) where all unskilled (skilled) labor is employed. Only one allocation of ( P , A ) that gives full employment. 14 / 36

Supply : The Math We have 2 Q A + 3 Q P = L U Q A + 3 Q P = L S Can solve both equations for Q P and set them equal to each other: L U 3 − 2 3 Q A = L S 3 − 1 3 Q A 3 Q A = L U 1 3 − L S 3 Q A = L U − L S and Q P = L S 3 − 1 3 Q A = 1 3 ( 2 L S − L U ) 15 / 36

Relative supply : US Relative supply Q A / Q P does not depend on P A / P P . 16 / 36

Relative supply : US Suppose we doubled the endowment of both kinds of labor – the relative supply of apparel is unchanged. Therefore, we can think of RS as a function of L U / L S alone. Is it increasing or decreasing in L U / L S ? I.e., what happens if we raise L U without changing L S ? 17 / 36

Relative supply : US L U ↑ − → Unskilled labor constraint shifts out − → Q A up, Q P down . 18 / 36

The Rybczynski theorem Q A ↑ , Q P ↓ when L U ↑ . This is a general result. Theorem An increase in the endowment of an input leads to increased output in the sector that uses the input intensively and a fall in output in the other sector (holding output prices constant). Intuition: If apparel output ↑ , then that sector needs more unskilled & skilled workers. The skilled workers must come from the plastics industry − → Q P must go down. Empirical example: Immigration to Norway last decade. 19 / 36

Immigration to Norway 0.14 ¡ 0.13 ¡ 0.12 ¡ 0.11 ¡ 0.1 ¡ 0.09 ¡ 0.08 ¡ 0.07 ¡ 0.06 ¡ 0.05 ¡ 1998 ¡ 1999 ¡ 2000 ¡ 2001 ¡ 2002 ¡ 2003 ¡ 2004 ¡ 2005 ¡ 2006 ¡ 2007 ¡ 2008 ¡ 2009 ¡ 2010 ¡ 2011 ¡ 2012 ¡ 2013 ¡ Foreign ¡born ¡rela7ve ¡to ¡total ¡popula7on ¡ Construc7on, ¡output ¡rela7ve ¡to ¡Mainland ¡GDP ¡ 20 / 36

Relative supply and equilibrium Assume identical rel. demand in China and US → Same RD curve. RS curves: ◮ High rel. supply Q A / Q P in China (bc L U / L S high). ◮ Low rel. supply Q A / Q P in US (bc L U / L S low). 21 / 36

The Heckscher-Ohlin theorem China: Low autarky price P A / P P . US: High autarky price P A / P P . Free trade: Price must be somewhere in the middle. ◮ China exports A , US exports P . Theorem Countries export the good that is intensive in the factor in which it is abundant. 22 / 36

Gains from trade in the aggregate Budget lines must intersect at A bc production (=income) unchanged. 23 / 36

Gains from trade in the aggregate New budget line cuts through the autarky indiff. curve. 24 / 36

The distribution of income In a perfectly competitive economy, profits are zero: Apparel: 2 w U + w S = P A Plastics: 3 w U + 3 w S = P P We’re interested in real wages, so divide by output prices and solve for w S / P A : Apparel: w S P A = 1 − 2 w U (1) P A Plastics: w S P A = P P 3 P A − w U (2) P A 25 / 36

The distribution of income w U ↑ − → w S ↓ to keep profits constant (at zero). The negative impact is stronger in Apparel bc that industry is unskilled labor intensive. Where lines intersect: Zero profits in both industries. 26 / 36

The distribution of income : The math Set (1) = (2): 1 − 2 w U P A = P P 3 P A − w U ⇐ ⇒ P A w U P P P A = 1 − 1 P A 3 → lower w U / P A (and even lower w U / P P ). Higher P P / P A − Insert the solution back into e.g. (1) to get w S P A = 1 − 2 w U P P P A = 2 P A − 1 3 → higher w S / P A (as well as w S / P P ). Higher P P / P A − (For US autarky, we get w U / P A = 1 − 1 / ( 0 . 48 × 3 ) ≈ 0 . 3 and w S / P A ≈ 0 . 4). 27 / 36

The Stolper-Samuelson Theorem In sum: US: Price of unskilled intensive good ↓ − → real wage of unskilled workers ↓ , of skilled workers ↑ . China: ? Theorem A rise in the relative price of a good will lead to a rise in the real return to that factor which is used most intensively in the production of the good, and conversely, to a fall in the real return to the other factor. Combined with the Heckscher-Ohlin theorem, the following must hold: The abundant factor will gain from trade, the scarce factor will lose. 28 / 36

The Stolper-Samuelson Theorem : In pictures Free trade: P P / P A ↑ − → Plastics curve shifts out (see equation 2) − → real skilled wages ↑ . Intuition: P P / P A ↑ generates profits in the Plastics industry − → Wages → w U ↓ . w S must go up. But that generates negative profits in Apparel − 29 / 36

Appendix: Allowing for substitution Suppose that apparel and plastics are both produced with CRS production functions using skilled and unskilled labor. Assume that for any ω = w U / w S ratio, the cost-minimizing unskilled-skilled labor ratio for apparel is greater than that for plastics: a UA ( ω ) a SA ( ω ) > a UP ( ω ) a SP ( ω ) . Apparel is unskilled-labor intensive. Plastics are skill intensive. 30 / 36

Unit isoquants 31 / 36

Zero-profit conditions again As before, Apparel: a UA ( ω ) w U + a SA ( ω ) w S = P A Plastics: a UP ( ω ) w U + a SP ( ω ) w S = P P Divide by output prices and solve for w S / P A : a SA ( ω ) − a UA ( ω ) Apparel: w S w U 1 P A = a SA ( ω ) P A a SP ( ω ) P A − a UP ( ω ) Plastics: w S P P w U P A = a SP ( ω ) P A 32 / 36

Stolper-Samuelson again 33 / 36

Stolper-Samuelson again If P P ↑ − ′ , w S / P A ↑ , w U / P A ↓ . → E to E 34 / 36

Gains from trade in the aggregate Previously: Production was fixed, no PPF to speak of. Now: P A / P P ↓ − → Specialization towards Plastic (A − → B). 35 / 36