Who Gains and Who Loses from Trade?
This chapter has two major purposes. First, it examines
the implications for factor income 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
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 depends 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.
conclusion about the effect of opening to free trade is an example of
the more general Stolper-Samuelson theorem -- the real returns to the
factor used intensively in a rising-price industry increase, and the
real returns to the factor used intensively in the falling-price
industry decline. 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
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 six factors-physical capital, highly skilled
labor, medium-skilled labor, unskilled labor, arable 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
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 rapidly and approach the real wages earned by comparably
skilled workers in industrialized countries.
The box "U.S. Jobs and Foreign Trade" 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 2-4 to the four key questions about
trade presented at the beginning of Chapter 2.
Factor price equalization theorem:
Under certain assumptions free trade will equalize not only commodity
prices between countries but also factor prices, so that all laborers
will earn the same wage rate and all units of land will earn the same
rental return in both countries regardless of the factor supplies or the
demand patterns in the two countries.
Factor specialization: The degree
of concentration of a factor in the production of a commodity or group
Neutral factor: A factor which
accounts for the same share of the value of output in all commodity
Magnification effect: The
principle that a factor's price changes by a greater percentage than the
change in the commodity price that caused it.
Stolper Samuelson theorem: Under
certain assumptions, moving from no trade to free trade unambiguously
raises the returns to the factor used intensively in the rising price
industry and lowers the returns to the factor used intensively in the
falling price industry, regardless of which goods the owners of the
factors prefer to consume.
Warm up Questions
True or False? Explain
1. T / F The Leontief Paradox may be resolved by using more
disaggregated definitions of factors of production.
2. T / F The Stolper Samuelson theorem says that trade will cause the
owners of the abundant factor to receive lower real incomes while the
real incomes received by owners of the scarce factor will rise.
3. T / F Nobel prizes are not given to dead economists.
4. T / F Factor prices will not be equalized by trade if technologies
are not the same in different countries.
5. T / F Unskilled workers in the United States should be more opposed
to free trade than skilled workers in the United States.
1. Studies of U.S. trade and its effects on employment of U.S. labor
show that, on average:
A. Trade has no effect on total employment.
B. Replacing imports (e.g. through protection from foreign
competition) saved (or created) more jobs than an equivalent expansion
C. Expanding exports creates more jobs than an equivalent amount of
D. Foreign competition has clearly raised the unemployment rate,
particularly in the 1980s.
2. After trade opens up, in the short run:
A. All groups tied to the declining sectors lose.
B. Only factors more intensively used in the declining sectors lose.
C. Only factors less intensively used in the declining sectors lose.
D. Only the most abundant factor in the country loses.
3. Mexico is an unskilled labor abundant country, while the United
States is a skilled labor abundant country. With the opening of trade
you would expect that in the long run wages for unskilled workers:
A. Decline in both countries.
B. Decline in the United States and rise in Mexico.
C. Rise in the United States and decline in Mexico.
D. Rise in both countries.
4. Which of the following statements is false?
A. Consumption patterns do not matter for welfare gains or losses
of neutral factors.
B. Consumption patterns do affect the size of the gains or losses to
C. Consumption patterns do not affect the direction of gains or losses
for the most specialized factors.
D. Consumption patterns do not matter for the welfare gains or losses
of a nation as a whole.
5. Factor price equalization will not hold if.
A. Factors are immobile between sectors of the economy.
B. Factors have different productivities in different countries.
C. Countries put up barriers to free trade.
D. All of the above.
1 . Recall our hypothetical trade model: Leinster is a labor abundant
country and Saxony is a land abundant country; telephones are labor
intensive goods and bread is a land intensive good. Assume that free
trade prevails between the two countries.
a. What happens to wages earned by workers in Leinster in the short
run? In the long ran?
b. What happens to wages earned by workers in Saxony in the short run?
In the long run?
c. According to the factor price equalization theorem, will labor wages
in Leinster equal land rents in Leinster, or will Leinster wages equal
2. Given the implications of trade Inodels for factor prices, how
would you explain an observation that, in the late 1980s, the hourly
manufacturing wage in West Germany was $13.44 while the wage was only
$7.46 in the United Kingdom?
3. Consider an economy producing capital intensive computers and land
intensive wheat. Labor is employed to produce both goods. If free trade
raises the price of computers relative to wheat, who would gain and who
would lose in each of the following two cases:
a. Factors are perfectly immobile between the two sectors.
b. Factors are perfectly mobile between the two sectors.
4. a. Have America's existing import barriers raised or lowered the
demand for U.S.labor? Explain.
b. Would a uniform percentage cut in U.S. imports raise or lower the
demand for U.S. labor? Explain.
5. You are given the following cost data for France, where they have
nothing but capital and labor and make nothing but bread and wine:
To make a
loaf of bread
To make a
bottle of wine
a. Is bread making more capital intensive than wine making or vice
b. Suppose trade opens and the price of wine rises while the price of
bread falls. If capital and labor were completely immobile between bread
making and wine making, who in France would gain from the shift in
prices? Who would lose? (Consider the four groups of bread capitalists,
bread laborers, wine capitalists, and wine laborers.)
c. Which group of consumers will rejoice with the winemakers in the
situation presented in question 5b? Which group of consumers will
commiserate with the breadmakers?
6. Suppose that a new isolationist government in Leinster decides to
shut off the country's imports of land intensive bread, preferring to
produce its own food instead of making labor intensive telephones for
export. After trade is shut off, bread becomes 14 percent more expensive
relative to telephones (i.e., telephones become 14 percent cheaper
relative to bread).
a. Over the long run how greatly, and in what direction, will the
isolation change Leinsterian laborer's real wage incomes?
b. Over the long run how greatly, and in what direction, will the
isolation change Leinsterian landlords' real rental income?
1. What do you think would happen to factor prices internationally if
an energy crisis tripled the cost of shipping goods around the globe?
2. Policymakers today are concerned about retraining unemployed
workers. Try to make a case for such programs as a means of increasing
public support for free trade.
1. True. 2. False: just the reverse is the case, with owners of
scarce factors seeing their incomes fall. 3. True: that's why Joan
Robinson will never receive the prize for her work on imperfect
competition. Proof•it is an imperfect world. 4. True. 5. True: unskilled
labor is used relatively more in the import-competing industries in the
1. C. 2. A. 3. B. 4. A. 5. D.
1. When trade opens up, the price of bread falls in Leinster and
rises in Saxony. At the same time, the price of telephones rises in
Leinster and falls in Saxony.
a. In the short run Leinster's bread workers see their wages fall,
while telephone workers see their wages rise. In the long run all
workers see their wages rise as labor moves out of the declining bread
industry and into the laborintensive telephone industry.
b. In the short run Saxony's bread workers see their wages rise,
while telephone workers see their wages fall. In the long run all
workers see their wages fall as labor is released from the
labor-intensive telephone industry but its not needed in great amounts
in the landintensive bread industry.
c. If the factor price equalization theorem holds, the wages of the
abundant workers in