interantional economics 5th by gerber CH04

Chapter 4
Comparative
Advantage
and Factor
Endowments

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Modern Trade Theory
• Differences in factor endowments lead to differences
in productivity
• Nations are endowed with different levels of inputs

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Heckscher-Ohlin (HO)
Trade Model
• A country’s comparative advantage lies in production
of goods that intensively use relatively abundant
factors
– Factor abundance: relative abundance of a factor, and
the factor’s relative cost is less
– Relatively scarce resources are more expensive

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TABLE 4.1 An Example of Factor Abundance

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Heckscher-Ohlin (HO) Trade Model

• The U.S. is richly endowed with a wide variety of
factors: natural resources, skilled labor, and physical
capital
• U.S. will export agricultural goods, machinery,
scientific and engineering goods

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Gains from Trade in the HO Model
• Ricardian model: constant set of tradeoffs (costs)
– One homogeneous input: labor
• The HO model: (1) multiple inputs—labor capital, land,
etc.—and (2) variations in the quality of inputs
• PPC under the HO model
– As produce more of one good, opportunity costs
increases

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Trade and Income Distribution
• The HO model:
– Labor can be divided into categories of different skill levels
– Other types of inputs can be included
– Industries can require different mixes of various inputs

• Systematic relationship between the factor
endowments of a country and the winners and
losers from trade

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The Stolper-Samuelson Theorem
• Assumptions:
–
–
–
–

Labor earns wages proportionate to its skill level
Owners of capital earn profits

Landowners earn rents
The amount of income earned per unit of input depends on
both the demand (derived demand) for inputs and the
supply of inputs

• Price of exported good rises, price of imported good
falls
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The Stolper-Samuelson Theorem
• An increase in the price of a good raises the income earned
by factors that are used intensively in its production
(exports)
• A fall in the price of a good lowers the income of the factors
used intensively in its production (imports)

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The Stolper-Samuelson Theorem
• Not all factors in the export industries will be better
off, and not all factors used in import competing
industries get hurt
• Abundant factors will benefit, while scarce ones will
be hurt

• Magnification Effect: the change in output prices
has a magnified effect on incomes.

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The Stolper-Samuelson Theorem
• Ultimately, the effects on income of an opening of
trade depends on the flexibility of the affected factors
• More flexible the resources are to adjust, the less hurt
they are.

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Specific Factors Model
• The HO model assumes that factors are mobile
• The Specific Factors model assumes:
– (1) land and capital are immobile and cannot migrate
(specific factors)
– (2) labor is fully mobile and can migrate from one sector
to another (variable factor)

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Specific Factors Model
• Endowment of specific factor plays a more critical role in
determining comparative advantage
– When trade opens, incomes rise for the owners of the
abundant specific factor
– Incomes decrease for specific factor in shrinking industry
– Effect on labor is indeterminant
– Prices in exporting industry rise, prices in importing
industry fall

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TABLE 4.2 A Specific Factors Model

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Case Study – Winners & Losers of
NAFTA
• Mexico: relatively abundant supplies of unskilled
and semiskilled labor
• US & Canada: relatively abundant supply of capital
and skilled labor

• Intrafirm Trade: Manufactures part of good in US
and ships to Mexico for remainder
• Moving production between US and Mexico has
gains and losses
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Table 4.3 Major Products in U.S.-Mexico Trade

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Table 4.3 (continued) Major Products in U.S.Mexico Trade

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Empirical Tests of the Theory of
Comparative Advantage
• Tests of theories based on factor endowments is
difficult
• Besides factor endowments, trade is affected by
–
–

–
–

Technological differences
Economies of scale
Corporate structures
Economic policies

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Extension of the HO Model:
The Product Cycle
• Evolution of manufactured goods and technology
• Early Stage: Likely in industrial countries
– High income consumers
– Scientific and engineering inputs
– Capital

• Middle Phase: Shifts to countries with low labor
costs, standardized technology
• Late Phase: More output shifted to developing
countries, industrialized ones focus on new goods
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FIGURE 4.5 The Product Cycle in High-Income Countries

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FIGURE 4.6 The Product Cycle in Low-Income Countries

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Table 4.4 Top Ten Chinese Exports to the United States, 2008

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Foreign Trade versus Foreign
Investment
• Based on product cycle, firms prefer to invest abroad
than export
• Substitute foreign investment for foreign trade
• Intrafirm Trade
– Internationl trade between parent company and foreignowned affiliate

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OLI Theory
OLI theory (Ownership-Location-Internalization)
– Firms investing abroad own an asset that gives them a
competitive advantage (Ownership)
– Firms seek a production location that offers them
advantages (Location)
– Firms try to internally capture the advantages of foreign
asset ownership (Internalization)

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Off-shoring and Outsourcing
• Off-shoring: Some or all of a firm’s activities move to a
location outside the home country
• Outsourcing: Reassignment of activities to another firm,
either inside or outside the home country
• Can use foreign affiliate
• Technology makes it easier
• Benefits from trading services should be the same as
traded goods.
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