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Chapter 5
Who Gains and Who Loses from Trade?
Overview
This chapter has two major purposes. First, it examines the implications for factor incomes of
trade that follows the Heckscher-Ohlin (H-O) theory. Second, it examines the empirical evidence
on the Heckscher-Ohlin theory and some of its implications.
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. Therefore, 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 depend on the factors
demanded by the expanding sector relative to the factors released by the contracting industry.
According to the H-O theory, the expanding sector is intensive in the country's abundant factor,
while the shrinking sector is intensive in the country's scarce factor. In the shift to free trade,
there is strong demand for the abundant factor (relative to the small amount released as the
import-competing sector shrinks), and there is weak demand for the scarce factor (relative to the
large amount released as the import-competing sector shrinks.) The shift to free trade increases
the price and income of the abundant factor, and it decreases the price and income of the scarce
factor. (The box “A Factor-Ratio Paradox” is difficult for some students, but it does show how
full employment can be reached after the shift, as each sector alters the proportions in which it
uses factors in response to the change in factor prices.)
Generally, the H-O approach has three major implications for factor incomes. First, 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. This theorem applies in a number of situations, if certain conditions apply (including
that the country produces both products both before and after the price change, and that the menu
of technologies available does not change).
Second, another way to view the broad pattern of the effects of shifting to free trade (or other
shifts which change relative product prices) is through the specialized-factor pattern—factors
more specialized in the production of exportable products (or rising-price products more
generally) tend to gain income, and factors more specialized in the production of
import-competing products (or falling-price products more generally) 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).
Third, 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. With no trade, the price of a factor will
be "high" in the country in which it is scarce, and "low" in the country in which it is abundant.
The shift to free trade increases the factor's price in the abundant country and decreases its price
in the scarce country. Under "ideal" conditions, the factor's prices (in real terms) become equal in
different countries. In its impact on differences in factor prices, product trade can be a substitute
for international movement of factors.
The chapter then shifts to examine empirical evidence on the Heckscher-Ohlin 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. It provides
evidence on endowments for seven factors—physical capital, highly skilled labor,
medium-skilled labor, unskilled labor, crop land, pasture land, and forest land, and it discusses
endowments of other natural resources. The 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. (The box “China’s Exports and Imports,” the
second in the series of boxes that Focus on China, shows that much of China’s trade is also
consistent with the H-O predictions, especially once we recognize China’s role in labor-intensive
assembly of electrical and electronic products that are then exported.)
According to the H-O approach and the Stolper-Samuelson theorem, the factors that gain from
free trade are those that are used intensively in export-oriented production, while the factors that
lose are those used intensively in import-competing production. The chapter presents evidence
on the factor content of export and import-competing production in the United States and
Canada, along with brief comments about other countries.
Finally, the chapter provides evidence on international factor price equalization. While it clearly
does not hold perfectly, even if we define factors carefully, we do see tendencies toward factor
price equalization. Most obviously, as countries in Asia have integrated themselves into world
trade, real wages in these countries have increased, to lessen international wage gaps. For China,
increased demand for less-skilled workers has led to rapidly rising real wages. For India, wages
for workers in business services have been rising relatively rapidly.
The box “U.S. Jobs and Foreign Trade” (another Focus on Labor) provides a survey of the
effects of international trade that focuses on employment. While this is not the most valid way to
examine the effects of trade (as noted at the end of the box), it is the way that much of the debate
actually occurs politically. The box shows that even on these terms the net effects on jobs are not
clear, because reducing imports also tends to reduce exports.
The chapter's summary pulls together the answers that have been developed in Chapters 2-5 to
the four key questions about trade presented at the beginning of Chapter 2.
Tips
We deliberately choose to bring out the implications for factor incomes using intuition and verbal
logic. Although this sometimes requires statements that are a bit vague (e.g., high or low factor
prices), it seems to work well in guiding most students to appreciate the reasons for and
meanings of the implications. For instructors who wish to do this more formally, Appendix B is a
starting point that presents the basics of the more formal analysis using the Edgeworth-Bowley
box diagram.
The theory of international trade can appear to be abstract. In the book we try to bring out its
application to the real world, often using the example of the United States (and also offering two
boxes that apply it to China). You may want to consider an assignment that asks students to apply
the theory to another country. The accompanying two pages under the heading “Sample
Assignment” shows a version of this assignmentthat Pugel (and others at New YorkUniversity)
have been using successfully. In this version students worked in groups on the assignment, but
they could also be asked to work individually. (In addition, each group also worked on a second
assignment later in the course using the same country.) The assignment might be distributed
about the time that you cover Chapter 5 in the course. However, as you can see, it does ask for
the application of concepts like intraindustry trade that are not covered until Chapter 6. In
addition, in answering the question about major trading-partner countries, students may want to
draw on the description of the gravity model in the box in Chapter 6. The due date should be
after Chapter 6 is covered in the course, if you use a comparable assignment.
