International Trade — Trade Models: Ricardo, Heckscher–Ohlin and Economies of Scale

International Trade — Why Trade Happens and Who Gains

Comparative advantage is subtler than “export what you are good at”. Productivity, factor endowments, economies of scale and product differentiation explain different trade patterns, and gains for the country as a whole must be kept apart from domestic distributional effects.

1. The Ricardian model compares relative labour productivity

Suppose Korea needs 4 hours of labour for one unit of semiconductors and 2 hours for one unit of wheat, while Australia needs 6 hours and 1 hour. Korea’s opportunity cost of semiconductors is 2 units of wheat; Australia’s is 6. Korea therefore has a comparative advantage in semiconductors, Australia in wheat.

Complete specialization is a result of the simple model: linear technology, no transport costs, full employment. Add increasing opportunity costs, many goods and trade costs, and partial specialization becomes the norm.

2. Heckscher–Ohlin links factor endowments and factor intensities

If two countries share the same technology and goods differ in factor intensity, the basic proposition is that each country exports the good that uses its relatively abundant factor intensively. Capital-abundant countries export capital-intensive goods; labour-abundant countries export labour-intensive goods.

But factor-intensity reversals, technology differences, trade costs, natural resources and global value chains change the predictions. “Advanced economy = exporter of capital-intensive goods” should not be used as a definition.

3. Trade creates both national gains and domestic conflict

The Stolper–Samuelson theorem shows, in a competitive model with two goods and two factors, that a rise in a good’s relative price can raise the real return of the factor used intensively in it and lower the real return of the other factor.

That winners could compensate losers and still come out ahead, in the Kaldor–Hicks sense, does not mean the people actually harmed are compensated. The political economy of trade policy arises from this gap.

4. Why similar countries exchange products of the same industry

Intra-industry trade — exporting cars while importing other cars — is hard to explain with traditional differences in factor endowments alone. Add monopolistic competition, product differentiation and internal economies of scale, and firms specialize in a limited range of varieties while consumers get access to more varieties.

When external economies of scale exist at the level of an industry or region, historical accident and first-mover advantage can lock in trade patterns. In that case comparative advantage can be both a cause and a result of industrial agglomeration.

5. Models are not competing right answers but lenses for different observations

The next chapter calculates, with welfare areas, how tariffs, quotas and subsidies change prices and surplus.

Check your understanding

In the example of section 1, both countries gain only if the world relative price of one unit of semiconductors lies between 2 and 6 units of wheat. As the relative price approaches 2, the gain for Korea, whose opportunity cost is 2, approaches zero and most of the gains go to Australia. The gains from trade are not automatically split in half.

References

• MIT OpenCourseWare, 14.54 International Trade
• World Trade Organization, Trade and tariff data
• Paul Krugman, Maurice Obstfeld and Marc Melitz, International Economics