McGraw-Hill/Irwin © 2012 The McGraw-Hill Companies, All Rights Reserved Chapter 5: Who Gains and Who Loses from Trade?

McGraw-Hill/Irwin ©2012 The McGraw-Hill Companies, All Rights Reserved

Chapter 5:

Who Gains and Who Loses from Trade?

The implications of H-O trade for factor incomes follow from the pressures for changes in production levels as a country shifts from no trade to free trade.

The export-oriented sector tries to expand production, as the relative price of the exportable good increases.

The import-competing sector shrinks its production, as the relative price of the importable good decreases.

In the short run, production factors cannot move easily between sectors.

In the short run, many or all factors employed in the export industry benefit from strong demand for their services and gain income.

In the short run, many or all factors employed in the import-competing industry suffer from reduced demand for their services and lose income.

In the long run, the period of time that is emphasized by the Heckscher-Ohlin approach, factors can easily move between sectors. The implications for factor incomes then depends on the factors demanded by the expanding sector relative to the factors released by the contracting industry.

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Figure 5.1 How Free Trade Affects Income Distribution in the Long Run:

The Whole Chain of Influence

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Exports Plus Imports as a Percentage of GDP

Figure 5.2 Winners and Losers: Short Run versus Long Run

International Factor Price Equalization

With the shift to free trade: For each factor, its rate of return becomes more similar between countries. Under ideal conditions, its real rate of return is the same in different countries.

Example: Labor. With no trade, the wage rate is high in the labor-scarce country.

The wage rate is low in the labor-abundant country.

With free trade, the import of labor-intensive products pushes the wage-rate down in the labor-scarce country. The export of labor-intensive products pulls the wage rate up in the labor-abundant country.

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A Factor-Ratio Paradox

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Figure 2.2 The Market for Motorbikes: Demand and Supply

Figure 5.3 Shares of the World’s Factor Endowments, 2007-2010

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Figure 5.4 U.S. International Trade in Selected Products, 2009

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China’s Exports and Imports

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China: Value of Exports and Imports, 1976-2009

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Figure 5.5 A Schematic View of the Factor Content of U.S. Exports and

Competing Imports

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Figure 5.6 The Factor Content of Canada’s Exports and Competing Imports

Summary

Three major implications for factor incomes:

1. The conclusion about the effect of opening to free trade is an example of the more general Stolper-Samuelson theorem—the real return to the factor used intensively in the rising-price industry increases, and the real return to the factor used intensively in the falling-price industry declines.

Three major implications for factor incomes

2. Another way to view the broad pattern of the effects of shifting to free trade is through the specialized-factor pattern—factors more specialized in the production of exportable products tend to gain income, and factors more specialized in the production of import-competing products tend to lose income. This pattern applies to both the short and the long run, and especially applies to factors that can only be used in one industry (sector-specific factors).

Three major implications for factor incomes

3. The H-O approach has a surprising implication for the earnings of a single factor in different countries. The factor price equalization theorem states that free trade that equalizes product prices between countries also equalizes the prices of individual factors between countries. The logic of this can be developed intuitively.

Empirical evidence on the H-O theory

The box “The Leontief Paradox” summarizes the early tests. The text emphasizes the kinds of information that we need to examine real-world trade patterns—factor endowments and trade patterns, along with knowledge of the factor proportions used in producing different products.  

Focus on endowments for six factors: physical capital, highly skilled labor, medium-skilled labor, unskilled labor, arable land, and forest land.

Examination of the U.S. pattern of international trade suggests that some of its trade seems consistent with the H-O predictions, but some also does not seem consistent. In general, trade patterns for the United States and other countries match the H-O theory reasonably well but not perfectly.