Heckscher-Ohlin Theorem


1. The First Traders

 Phoenicians  These seafaring Phoenicians were the first maritime traders, selling purple dye to four corners of the world (as in the Arabian Night and the Bible). They also invented the alphabet. Subsequently, through trade with these Phoenicians, the Jews invented the Hebrew scripts, which are mostly consonantal except for aleph and vav, the latter serving not only as a consonant (v) but also as an indeterminate vowel (o or u). They had a trade monopoly, shipping goods from one location to another in the Meditteranean Sea. (Other races did not have the navigation skills then.)
   Many archeologists believe that Cretans left the island and migrated to Lebanon. (The Peace Encyclopedia). Cretan murals are found in Israel, Lebanon and Egypt.

Phoenicians/Cretans made great contributions to human civilization: (i) Phoenicians invented alphabet, (ii) Cretans invented plumbing, which is essential to modern houses, and (iii) created an architectural style with columns.

What it was like in the Palace of Knossos, 2000 - 1380 BC, a modern painting in Knossos, Crete, based on the remaining columns and artifacts. The palace was a labyrinth, and new comers got lost in the palace.

 

peristyle of Predia Iulia Felix, Pompeii.

 

Trade promotes exchange of ideas. Countries adopt the technology and culture of a superior economy.

   
A fragment of ceiling, which appears in the the painting on the left.
   This jar is evidence that Cretans were seafarers. Octopus appears in many jars.
  These columns are about 4000 years old. These architectural styles are copied by the Western people ever since.
A Minoan larnax (bathtub). It appears our bathtubs were an idea borrowed from Cretans. Crete was plumbers' paradise. Their houses had fresh water indoor plumbing. The diameter of terracotta drain pipes were 4 - 6 inches.

Lustral basin for purification. Greek bath was for ritual purification.

   

 

2. Assumptions

 1 - 8

same as those for FPE

 9. Balance of Trade and No Leakages  p*1z1 + p*2z2 = 0, (total value of imports must be equal to the total value of exports)

zi + z*i = 0. (No leakages. Nothing is lost in transit)

 

10. Identical and homothetic preferences between countries.

Homothetic preferences implies: As income increases consumption increases proportionately, i.e., the income elasticity of demand for each good = 1.

Income consumption curve is a ray from the origin.

Figure 1. Homothetic preferences

   

 

3. The HO Theorem

   If assumptions (1) - (10) are satisfied, then each country exports the commodity which intensively uses its abundant factor.
 Example For example, if China is abundant in labor, it will export the labor-intensive product to the US. If the United States is capital abundant, it will export the capital-intensive product to China.

To prove the HO Theorem, we first need some definitions.

 Absolute (physical) Abundance Home Country is abundant in labor if

L/K > L*/K*

Figure 2. Abundance in labor.

HC is abundant in capital if

K/L > K*/L*.

Proof of the HO Theorem

 Remark: Supply of y1 is positively related to p1/p2 whereas supply of y2 is negatively related to p1/p2. Thus, the relative supply y1/y2 is positively related to p1/p2. Similarly, demand for x1 is negatively related to p1/p2 whereas demand for y2 is positively related to p1/p2. Thus, the relative demand x1/x2 is negatively related to p1/p2, as shown in Figure 3.

Since consumers in the two countries have identical preferences, relative demand are identical, i.e., x1/x2 = x*1/x*2 . However, while the relative supplies, y1/y2, and y*1/y*2 both positively sloped, they are not identical, as shown in (1).

   Figure 3. Relative demand and supply
   Figure 4. HO Theorem
   

 

4. The Original version of the HO Theorem

 

The original HO Theorem, however, was expressed in terms of relative abundance.

 An economy's offer curve depends on both production and consumption conditions in that country. In the Ricardian trade model, it is easy to derive offer curves because each country specializes in the production of one commodity. This means that as the price of good changes production remains unchanged.

          In the HO model, a change in the terms of trade, p* = p*1/p*2, necessarily results in a change in production mix. (Input allocations change, which alters output). Thus, it is a little tricky to derive an offer curve. First, note that an increase in the price of the capital intensive good reduces the wage-rent ratio, and decreases the capital intensities of both goods. This in turn causes a change in output mix.

A trade indifference curve can be obtained from PPF and a community indifference curve. This can be shown in two steps, using a technique developed by James Meade, who received a Nobel prize in economics in 1977.

 Trade Indifference curve  Definition: Trade Indifference curve is the locus of export-import combinations that yield the same level of utility. U(z1,z2) = U(x1 - y1,x2 - y2),

where zi > 0 (import) (negative = export). Thus, to obtain a TI, we must subtract production from the indifference curve defined on consumption.

Figure 5. Trade Indifference Curve

 The HO Theorem (Original)  If assumptions (1) - (9) hold, and if the HC is relatively abundant in labor, i.e., (w/r)A < (w*/r*)A

then HC exports the labor-intensive commodity.

   Assume that k2 > k1.

By the Stolper-Samuelson Theorem, p1 and w are positively related, i.e., at the origin p1/p2 < p*1/p*2 iff w/r < w*/r*.

(2 offer curves): HC, abundant in labor (w/r < w*/r*), exports good 1, which uses its cheap factor (labor) intensively (and imports 2).

Figure 6. An Alternative Proof of HO Theorem.

 Remarks No need for the assumption of identical and homothetic preferences.

Absolute or physical abundance is empirically observable. One needs to gather data on factor supplies. However, relative abundance is difficult to observe. Trade data only reveals observed prices, not the hypothetical output or input prices that would be observed under the autarky scenario. This is a weakness. For this reason, empirical tests are all based on physical abundance.

   

5. Trade and Business Cycles


A ritual vessel during Shang Dynasty (1766-1122 BC), long before Moses (c. 1250 BC), Smithsonian Institution.

Shang traded bronze mirrors and tea.